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Why BT Group plc and Persimmon plc have the qualities Warren Buffett looks for

Their shares may have gone in completely opposite directions over the last year or so but communications giant BT (LSE: BT-A) and housebuilder Persimmon (LSE: PSN) are just the sort of stocks that might interest investment poster boy Warren Buffett. Here’s why.

Value AND Quality

In contrast to his early days as an investor looking for ‘cigarette butt’ stocks (companies trading below their liquidation value but from which holders could enjoy ‘one last puff’), the Sage of Omaha’s strategy over much of his career has been to buy great stocks at reasonable prices. So how do BT and Persimmon measure up?

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Right now, both companies trade on 11 times forward earnings, reducing to 10 in the next financial year assuming earnings growth forecasts can be met. Using a rough rule of thumb that anything below 15 tends to indicate value implies that both stocks are currently very reasonably priced, perhaps even screamingly cheap. In addition to this, their price-to-free cash flow ratios are also fairly low (another indication that a stock may be undervalued).

As far as quality is concerned, both companies have demonstrated their ability to grow operating profits and returns on equity (the return generated for every pound of equity on the balance sheet) over many years. Despite recent wobbles — some of which are of its own making (see below), BT’s operating profits still hit £2.6bn last year and returns on equity have not dipped below the desired 15% mark. Persimmon’s returns on equity have climbed from 8.7% in 2012 to just over 24% in 2016 while operating profit has more than quadrupled over the last five years.

Not risk-free

That’s not to say that an investment in either BT or Persimmon is devoid of risk. Indeed, while Buffett looks at financials for signs of quality and value, he also recommends looking beyond the numbers when evaluating a company. Focusing on the more qualitative aspects of a business could involve a consideration of its ability to outperform competitors and whether or not it is in a declining industry.

While BT remains a major player, the accounting issues in Italy earlier in the year have clearly knocked investor sentiment. The huge fall in the share price back in January remains a great example of just how quickly the market will punish a business if nasties are found, regardless of its size. Right now, the direction of travel for the share price is still to reverse and could continue to drift lower until BT reports on Q2 trading in early November. The size of its pension deficit also remains worrying. 

As a housebuilder, Persimmon’s fortunes are, of course, very much dependent on the general health of the economy. With the number of mortgage approvals falling to a nine-month low in June, house price growth slowing in August and Brexit at least somewhere in the distance (probably), there’s no way of ignoring the fact that this well run company still operates in a hugely cyclical industry.

Assuming the aforementioned risks aren’t enough to derail either business however, investors stand to collect chunky dividends from both companies this year. As things stand, BT and Persimmon each offer yields over 5%. Regularly reinvesting these payouts will never get you to the level of wealth enjoyed by Buffett, but such a strategy can still make you significantly richer.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.