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What would Warren Buffett do about these cheap shares?

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When seeking insight into whether a share price is a good buy, I often find myself turning to the Sage of Omaha for answers.

Warren Buffett is regarded as a kind of deity among value investors. Not because he can see the future, or has special superpowers, but because he looks at the right measurements to truly tell us how well a business is doing and what its future prospects may be. It’s a rarer skill than you might imagine.

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A good fit

The share I have in mind is Howden Joinery Group (LSE:HWDN). The trade kitchen supplier ticks a lot of boxes for me. It’s far and away the leader in an otherwise crowded marketplace.

Because it sells to both trade and retail buyers, it can manage costs to a much lower level than anyone else. And it opened 15 new depots in the first half of 2019 in order to scale up earnings and profits. The return on capital employed – the investments management is making to grow the business – was very high at over 43% last year.

Political analysts appear to have concluded that a Conservative government is the most likely outcome from the upcoming 12 December general election, even if a majority is still in doubt. The small amount of certainty this brings to the market means otherwise high-quality shares which had previously dragged are now starting to perform.

Watch the numbers

A trailing price-to-earnings ratio of 20 gives Howdens a reasonably interesting valuation.

Earnings are slated to be 7.8% ahead of 2018’s effort, which adds around 0.7% to previous years’ growth.

Howden’s return on equity (ROE) of 35.7% is considered to be high, at over 20% greater than the trade distributors’ market average. This is a favourite measurement of Mr Buffett when considering stocks he can add to Berkshire Hathaway’s $538bn stockpile.

Dividend cover is especially high, never dipping below 2.7 times earnings in the last five years. The dividends aren’t spectacular at around 1.8% but the share price has returned a 41% increase over the last 12 months which, if this kind of growth continues, would make it a good buy.

Operating profits are growing steadily rather than spectacularly: 2018’s effort hit £240.1m, up just £6m from the year before. Forecasts suggest that 2019’s year-end results will show £262m

The Buffett bounce

Consistently high ROE, Buffett says, indicates that a company is making good profits and that management is using cash flow in a way that creates the best value for its shareholders.

Elsewhere, the business is in rude financial health. It is entirely debt-free, so there are no interest or loan payments to think about. Short-term assets of £667m cover liabilities by a ratio of 2:1.

Another of Warren Buffett’s favourite metrics is profit margin: Howden’s is 61.9%, which is growing year on year.

CEO Andrew Livingston made all the right noises in 2019’s half-year results, highlighting “positive performance” and pre-tax profits up strongly, adding “we ended the half year with £217m in cash, having invested £24m in the business and having returned £46m to shareholders.”

With international investors now being urged to look at the UK market to pick up relatively undervalued shares, I think Howden’s could be at or near the top of a lot of wishlists.

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Tom has no position in any shares mentioned. The Motley Fool UK has recommended Howden Joinery Group. 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.

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