Bruce Greenwald on Value Investing

American Express, WellPoint top the noted professor’s list


What do you think of Warren Buffett's move so far into Goldman Sachs and General Electric?

First of all, Goldman and GE are not real Warren Buffett moves. They're literally what he did at Solomon Brothers. He got paid very handsomely both in terms of a high return and protection on the downside. His preferred carries a significant interest return on it and is protected in event of a catastrophe. He got a very favorable deal. This is not the kind of real investment he's making. He has talked about accumulating further positions in one of two financial services companies. I don't know if he's had to reveal which one yet, but it's either American Express or Wells Fargo. There you can see what he's looking at. American Express is easier because it doesn't have all the complexity of a bank.

Greenwald on the best value bets in the market now:

American Express: If you ask yourself what the average yearly earnings should be even in a fairly distressed economic environment, it's probably about $3.50 a share. Typically, they commit to pay out at least half of those earnings to you in cash, so you're getting a 7 percent cash return either in buybacks or the dividend. Then they reinvest 7 percent of your money. In the short run, where that money is going is cash to protect themselves financially against any catastrophic drop in credit card repayments, but in the long run it's going to credit card loans, and the economics of those are fairly transparent: They lend at 15 percent, borrow at 4 or 5 percent, have a 10 percent margin, and the default rate is around 5 percent. So they make 5 percent on every dollar of loans, and they leverage up because you can because it's fairly safe. Even if they do 7 to 1, which is a fairly conservative ratio, you're making 5 percent times seven on your unemployed equity capital which is 35 percent, or 20-percent-plus post-tax. And billings by American Express just grow over time. It's probably faster than GDP because they have high-income customers, and spending is skewed towards services, which are growing faster than (spending) on goods. You probably get another 5 percent even making conservative growth (projections). You're looking at returns, without any improvement in the multiple, of well over 20 percent. That's the sort of investment (Buffett) sees. It gives you an enormous margin of safety for long-lived bad economic conditions.

WellPoint: You've got an annual earnings return of 14 to 15 percent, and mostly its going into cash. You know they're just a toll on medical expenditures in certain parts of the country, and those will be growing at 5 percent no matter how you look at that. That's a 20 percent return. Buffett's not greedy. He'll live with that all day long. These are safe companies with dominant market positions and trustworthy managements. They may go down in value before they go up, but the long-run prospects are so stable and attractive that I think he's right to be investing in these things.

Magna: It recently traded at a market capitalization of $3.6 billion, and it's got $1.7 billion in net cash. They're not going to run out of money, so you're paying $1.8 billion or $1.9 billion for the business. That business this year, if you look at average margins—and this year it's a little lower because they're at the trough of the cycle—is going to earn about 5 percent on sales of about $26 billion, so you're talking about $1.3 billion of pretax earnings you can buy for $1.9 billion. Then, if you look at the assets and the cost of reproducing those, you have about $8 billion of assets in the business to protect you. If you just take that earnings power, after tax, of about $1 billion, and you say in a risky industry like autos you want a 12 percent return, that's an 8 multiple. That's a case where you're being very conservative about earnings, you're backed by assets, there's a lot of cash, and, even though autos are a fraught place to be, you're buying those $8 billion in assets less than $2 billion. That's got to be the kind of bargain you're looking for.