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Could One Of These Stocks Be Warren Buffett's Next Big Purchase?

 February 29, 2012 10:12 AM

"I'm on the prowl."

Those four words were tucked in to Warren Buffett's just-released 2011 annual letter to shareholders.

And the mad dash begins to figure out what company may be in his sights.

Such an exercise might preoccupy the financial media simply for the sake of covering Buffett (which always attracts an audience), but if done right, it can actually lead to uncovering compelling stocks that might be worth buying -- even if Buffett doesn't buy himself.
First, it's worth noting that in recent years, he's picked up the pace of major investments: Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) completed a $34 billion acquisition of railroad Burlington Northern in early 2010, and then picked up lubricant maker Lubrizol for a cool $9 billion in the spring of 2011.

So what will he do in 2012?

Well, those recent deals give a clue. On the surface, railroads and lubricants appear to have little in common. But those two firms are known for robust recurring cash flow --, in almost any economic environment.

The questions for investors are now:

• How much would he be willing to spend for his next blockbuster purchase?

• And what companies have the makings of a perfect Buffett stock?

First off, another $34 billion purchase would be a stretch. During the past seven years, Buffett has never let Berkshire's cash balance slip below $25 billion. (He says he believes in saving "rainy-day money" for crazy bargain opportunities, like he did on Aug. 8, 2011 when he spent billions on plunging stocks.)

Berkshire had $35 billion in the bank as of Sept.30, 2011. That figure now likely approaches $40 billion. By that math, Buffett might like to spend up to $15 billion on any deal, perhaps $20 billion as an absolute maximum. Considering he'd have to pay a premium to receive acceptance of a buyoutoffer, then we're talking about companies that are currently valued at less than $15 billion. He probably wouldn't waste his time looking for small deals, so the minimum value of any target would likely be around $5 billion.

Of course, for Buffett, it's all about the cash flow. I've compiled a table of U.S.-based companies with a market value in the $5 billion to $15 billion range, all of which currently sport free cash flow yields in excess of 5%.

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