Legendary investor and billionaire Warren Buffett runs Berkshire Hathaway (BRK.A -0.39%) (BRK.B -0.56%), one of the world's largest holding companies. Buffett is famous for his longtime investments in famous consumer-facing companies like Coca-Cola, Apple, and American Express. However, Buffett has made it a point to reduce his broad stock exposure over the past several quarters, raising Berkshire's cash position to a record high of over $325 billion.
Berkshire recently released its quarterly 13F filing, which discloses the company's trades in recent months. Buffett didn't buy much, but Berkshire did increase its stake in Heico (HEI 0.16%), a company that many people have probably never heard of. It's time to shine a light on this market-beating stock that more people should be familiar with.
Here is why Heico might appeal to Buffett and whether the stock is a good buy today.
The market-beating stock many people don't know about
Heico cuts against Buffett's affinity for consumer-facing brands. Heico supplies components for aerospace, aviation, industrial, electronic, and military applications. The company generates approximately $3.8 billion in annual sales, split roughly 2-to-1 between its two business units: flight support and electronic technologies.
The company has been public for decades, and it has crushed the S&P 500 index over its lifetime:
HEI Total Return Price data by YCharts
How? Heico is a serial acquirer. The industrial components space is highly fragmented. Many small companies supply parts and components to various end markets. Heico snatches these companies up when an opportunity arises, expanding their product offerings. It's been a big driver of the company's long-term growth. Heico has acquired nearly three dozen companies since 1999.
Heico's strong execution likely attracted Buffett
So, what ultimately attracted Buffett to Heico? You can't read Buffett's mind, but you can look for clues. The best place to start could be: What has made the stock perform so well?
I'd point to the company's sustained, efficient growth. Stocks will likely do well if the company grows larger, as Heico has done. However, it takes an efficient and profitable company to generate the level of returns you've seen from Heico stock. Perhaps most importantly, Heico has steadily generated a higher return on equity (ROE) over time:
HEI Return on Equity (3y Mean) data by YCharts
That signals a well-run company. Management must wisely use its financial resources to invest in its business, pay reasonable prices for acquisitions, and manage its balance sheet. A growing, well-run business will, more often than not, generate the earnings growth that drives exceptional investment returns over the long run.
Is there value in buying the stock right now?
Buffett is notoriously picky about the prices Berkshire pays for stocks. It's worth noting that Berkshire's Heico stake is only about 0.1% of its portfolio, and its third-quarter buying was more like a nibble. Berkshire's Q3 purchases only increased its stake by less than a percentage point. Based on Buffett's tepid buying, Heico stock seems expensive.
The numbers back that up. The stock trades at a forward P/E ratio of 65. Meanwhile, analysts estimate the company will grow earnings by almost 20% annually over the next three to five years. That boils down to a PEG ratio of 3.3, a steep price based on Heico's anticipated future growth. I generally like to see PEG ratios under 2.5 for the best businesses and 2 for most others.
Heico is still a new holding for Buffett; Berkshire's first purchase was only in the prior quarter. Investors should probably take Buffett's hint and nibble at these prices. Keep some cash handy in case a broader market decline knocks Heico stock to a more attractive level. I wouldn't be surprised if this ultimately winds up being Buffett's plan, too.
