The news of legendary value investor Warren Buffett making his first direct investment in the Australian stock market through a stake in Insurance Australia Group (ASX: IAG) sent the financial press into a frenzy.
But for long-term value investors, the interviews with the so-called Oracle of Omaha that followed were just as interesting. Buffett clearly indicated that the IAG purchase was not likely to be his last in Australia, and that he would be looking to deploy the capital earned from the investment in the local market.
So which stocks would likely be on Buffett's watchlist?
As a general note, Buffett's company, Berkshire Hathaway, would only be looking at the larger end of the market for its next investment. For a multibillion-dollar conglomerate like Berkshire, anything less than a large investment would not "move the needle" on earnings. That narrows the field considerably. Here are three I think should make the cut.
Australia and New Zealand Banking Group (ASX: ANZ)
This is perhaps the most obvious of the potential stocks on Buffett's radar. In interviews on Tuesday, he repeatedly stated that an investment in Australia's banking sector was one he was actively looking at. Buffett is also known for investing in banks, and U.S. lenders JP Morgan and Wells Fargo are two large positions in the Berkshire portfolio.
But ANZ is the local bank most likely for one main reason: Its Asian expansion strategy lifts it above its more domestically focussed peers.
And of course, for those who are sceptical, there is this quote from Buffett himself describing the rationale for the IAG investment. It could just as easily be describing a future purchase of ANZ stock: "The idea of participating in Asia in a significant way with someone who knows what they're doing is enormously appealing to us".
CSL Limited (ASX: CSL)
Although it has appeared more in the press recently in the context of "race to $100" type articles, CSL is one of the stocks that should survive the rigorous Buffett investment process.
First of all, it has consistently delivered a rising return on equity (ROE), which is one of Buffett's favoured metrics. In the past five years, management has lifted ROE from 25% to 41.3%.
In addition, Buffett and Berkshire Hathaway are known to favour companies that have a history of returning cash to shareholders through effective capital management. CSL is one of the best exponents of this on the Australian market, having recently completed yet another multimillion-dollar stock buyback with surplus cash from its existing operations.
CSL also displays the entrepreneurial management that Buffett favours, most recently shown by the purchase of the Novartis flu vaccine business, which considerably strengthens CSL's position in that market segment.
Finally, CSL is one of only a few Australian companies with truly global reach, and it reports earnings in U.S. dollars, two factors likely to prove attractive to an investor like Warren Buffett.
Challenger Ltd (ASX: CGF)
Buffett is known for his legendary patience and long investing horizon. Indeed, in his interviews with the Australian media, he was quick to point out that while he didn't know which way the market was headed in the next six months, he was comfortable that in the next 10 to 20 years, it would grow.
That kind of view is the reason that Challenger could be attractive to Buffett. Like IAG, it is in the financial services space. But unlike IAG, it has the tailwind of a generational avalanche of Australian baby-boomers retiring and looking to protect their incomes. That will drive demand for Challenger's annuity products, where it currently has a dominant competitive position.
Buffett is known for selecting investments in companies with wide moats and competitive advantages, and Challenger appears to have both of those things as well as favourable market forces acting in its favour.
The Australian financial services and insurance sector has proved attractive to overseas investors before, as shown by the purchase of Tower Australia by a Japanese company several years ago.
It is impossible to predict with certainty where Warren Buffett and Berkshire Hathaway will invest next in Australia. However, there are quotes and investing traits that can provide clues, with the three companies above all exhibiting these potential signals.
