In 2016, Warren Buffett pay 32 B to buy aero parts supplier, Precision Catspart. At that time, the valuation for the maker of jet components is around 22 earnings multiple (P/E ratio = 22). In 2021, The Oracle says it is too much – too expensive. Here in Warren Buffett Investing Analysis, we try to look closer at that decision.
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Warren Buffett Investing Analysis: In This Issue
According to its letter to shareholders and annual report for the Fiscal year 2021, Berkshire Hathaway1 records a loss regarding the Precision Castpart acquisition. The number can’t be overlooked, almost 10 B or 25% of its earnings in FY 2021 is attributed to that loss. Here is our outline for this issue:
- Into Valuation: Warren Buffett Number – actually it is Todd Comb.
- Criterion Checked: Moat, Manager, Make Sense
- Distorted by The Virus: Different Story
- Key Takeaway: Points
- Lesson from Precision: Never Precise
Precise Look at Precision Castpart
The idea of this section is to find how much actually Waren Buffett willing to pay for that most expensive acquisition in his life. We try to get the “ratio” number, thus it can be extended or applied for another security or investment.
Buffett bought Precision Castpart for 32 B, dividing this number with its eaning in 2016 – around 1.5 B give us 22 earning multiples. Now, If Buffett says that investment loss is almost 10 B, we could assume that 22 B is the number that Oracle of Omaha willing to pay.
We believe this step is due to a pandemic (and Boeing crash). This duo devil forced The Oracle2 to revise revenue for Precision Castpart, the aero supplier will drop its revenue as well as earnings around 30% (thus give us earning around 1 B).
Interesting to note that a 10 B loss in Berkshire 10-K filing is around 30% of its acquisition cost. Thus, we have the same multiple earnings here. We get that figure by dividing the amount Warren Buffett willing to pay which is 22 B with its 1 B earning (in 2020).
P/E 22 is Warren Buffett number for business like Precision Castpart.
So, before we nail that number “P/E = 22” to perform the valuation for another business, we should understand what Precision Castpart looks like. If we get similar characteristics, we are ready to apply that approach.
Warren Buffett Investing Analysis: Unholy Trinity
Warren Buffett has criteria to evaluate his investment. They are:
- Good return on invested capital and competitive advantage durability.
- Honest and skillful managerial
- It is available at sensible prices.
First , the economic moat and return on invested capital.
Precision Castpart supply nuts, bolt, material for jet engine maker like GE aviation. FYI, the jet engine operates in very extreme conditions. It spins very fast under very high temperatures – around 1,0000 F – a level that could melt iron like a soup.
Manufacturing this kind of material is far from easy. Thus, we can say that Precision Castpart is a company that operates with a high barrier to entry with almost no meaningful competition.
Economic Moat – checked.
For readers who eager to know the business advantage of the aero-related industry could access it here.
Return on Invested Capital isn’t spectacular, moreover, companies like Precision need a high level of CAPEX to maintain their business. This company is far from Warren Buffett’s favorite industry: insurance, banking which need only a little capital to grow or to maintain their market share. Though, according to our analysis, it is ok to get this “so so” return with a very strong – almost unpenetrable – economic moat. Well, It is a little bit defensive choice.
Return on Invested capital, well….checked.
The second is management stewardship.
Mark Donegan is CEO of Precision Castpart. He may be hated by some of his employees, but as a leader for a company, shareholders won’t have any objection. Donegan is ambitious, he is obsessed to keep leading with the competition – thus it is no surprise that Precision Castpart become key partner of high-profile companies like GE Aviation, Airbus, Boeing.
He is the man with energy, passion.
In his 13 years tenure, revenue quadruples, and the stock flew 20-fold. Yes, you hear it right, 20- fold, so value investor Guru (Mr. Buffett) buy a stock that has been skyrocketed to 20-folds.
In 2014, Barron list him as one of the world’s best CEO, need another name on that list? Warren Buffett.
No question for management, checked.
Now we have been illuminated a bit.
As we have discussed, 22 earnings multiple is Warren Buffett’s number and preferences for business with this type of economic moat and management capability.
The Pandemic. What Really Going On
So, what happens? In our analysis, we think that Warren Buffett “just” adjusting his calculation – he doesn’t miscalculate, even he takes the blame. In 2016, When he acquired Precision Castpart via Berkshire Hathaway, the price is good, the moat is great, the management is good – till the Pandemics come. People do not fly again, deglobalization, everyone is in his home. Then the revenue is plunge since the aircraft maker doesn’t manufacture its product at optimal capacity.
Because of the pandemic, Warren Buffett revises his calculation, and – with honesty, he put that loss in Berkshire Financial Statement. His integrity makes him be transparent and accountable.
In our opinion, nothing wrong with Precision.
Another things that strengthen our opinion are:
- Buffett sells its airline stock in 2020. We have a common understanding regarding that year: Coronavirus.
- Buffett doesn’t sell its Precision Castpart and Berkshire keeps it private. Before the acquisition, Precision Castpart is a public company, you can find its ticker PCC. So in 2016, Buffett wants to keep it alone for Berkshire, confidence about its future earning – in 2021, we believe Buffett still wants to keep it as a Berkshire subsidiary.
The Takeaway from Our Warren Buffett Investing Analysis
Great business with durable competitive advantage along with good management worth for 22 earning multiples. That is the lesson. To make the briefer picture, Warren Buffett buys Apple in 2016 when the stock hovering at a 16 P/E ratio or multiple earnings.
So, we may guess that Buffett’s preference number is around 16 to 22, assuming the FED doesn’t bomb the market as they did in 2020 – beyond that, we need to make another adjustment.
Precision Castpart’s Lesson: You Can’t be Precise, It’s a Part of Business
That is our review on a slight of Buffett investing strategy, but, to extend, we believe we could draw another lesson:
- Even the best make mistakes. None knows the exact future. Before coronavirus, none ever imagine that people sealed in their home. Making predictions is exhausting, even more, when it turns to fail.
- Always open to change. We are living in changing environments thus when it comes, we should adjust our calculation.
Hope it helps