Would Warren Buffett Buy This UK Stock?

09/07/2012 9:30 am EST

Focus: GLOBAL

This investment services firm may not be a screaming value, but it does have the "moat" that the Sage of Omaha craves, so Malcolm Wheatley of Motley Fool UK analyzes the stock to see which argument wins out.

Warren Buffett is one of the world's smartest-ever investors. Berkshire Hathaway (BRK-A)—the ailing textile company that Buffet bought into in the mid-1960s and turned into a world-beating investment vehicle—has delivered returns of over 20% per annum since 1965, and turned Buffett himself into the world's third-wealthiest person.

Given all this, many investors make the mistake of thinking that Buffett must use high-tech financial models and advanced discounted cash flow techniques to select the businesses that he buys into.
In fact, nothing could be further from the truth.

Moats
As Charlie Munger, Buffett's partner, once put it at an investors' meeting: "Warren often talks about these discounted cash flows, but I've never seen him do one."

"It's true," replied Buffett, acknowledging that to experienced eyes, a good share just looked like a good share. "It's sort of automatic...It ought to just kind of scream at you that you've got this huge margin of safety."

So how does Buffett tell if a share would be a good pick? While a look at the financials certainly plays a part, it's a part that comes only at the end of multi-stage process—a process that includes an early evaluation of that famous "moat" with which he's often associated.

As the man himself puts it: "In business, I look for economic castles protected by unbreachable 'moats'."

In short, Buffett is looking for:

  • A business that he understands
  • Favorable long-term economics
  • An able and trustworthy management
  • A sensible price tag

So would Hargreaves Lansdown (London: HL) pass the test? The company reported its full-year results today, so I thought I'd take a look.

The Fundamentals
Hargreaves Lansdown was set up in 1981 by co-founders Peter Hargreaves and Stephen Lansdown—who between them still own over 50% of the business.

The company caters for individuals who want excellent service, yet are happy to make their own investment decisions, a growing trend. Key products are its "Vantage"-branded investment accounts. Better still, the hefty investments in these platforms have long-since been made: new customers add little by way of additional cost, and a lot by way of additional profit.

Based in Bristol, Hargreaves Lansdown prides itself on its approach to customer service, and a May 2011 client satisfaction survey showed that 96% of the company's clients rated the service good, very good, or excellent. Irrelevant? Not to Buffett, who sees loyal customers as part of that famous moat.

And in 30 years, Hargreaves Lansdown has gone from small beginnings in a spare bedroom to a publicly quoted company that is a member of the FTSE-100 index. As of March 31, it held £26 billion of assets under administration on behalf of over 413,000 private investors. The market cap is £2.9 billion.
 
Would Buffett Buy?
Over the last five years, Hargreaves Lansdown has grown revenues by 20% a year and pre-tax profit by 50% a year—no mean feat in a recession.

Over the same period, earnings per share have grown by 33% a year, and dividends by 44% a year. "Special" dividends, declared on a discretionary basis, boost investors' returns still further.

Throw in the company's moat—its market dominance, Vantage platform, and unparalleled reputation for customer service—as well as its long-serving co-founders, and the mix begins to look compelling.

Granted, Stephen Lansdown, who has taken something of a back seat in recent years, has today announced his retirement from the board. But successors to he and Hargreaves are already in place, and Buffett and Munger, who in their eighties, are doubtless sanguine about managers and shareholders in their sixties.

Throw in today's results—another 20%-plus increase in pre-tax profits on the back of revenues boosted by 15%—and the picture is clear.

Would Buffett buy Hargreaves Lansdown, whose shares are changing hands at 630p today? Despite a price-to-earnings (P/E) ratio that, at 21.9, is almost twice the market average, the answer, I believe, is yes. Good businesses aren't always cheap, and it's better to get a good business than a cheap business.

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