Warren Buffett’s investment criteria are simple in theory. They involve finding shares in companies with strong future prospects trading at reasonable prices.
I tried asking ChatGPT for shares that fit this description right now. And, along with some familiar names, it listed a really interesting FTSE 100 stock I haven’t looked at before.
The usual suspects
At the top of the list were Occidental Petroleum, Constellation Brands, and Domino’s Pizza. Solid choices, but no surprises – Buffett’s investment vehicle Berkshire Hathaway bought all three in Q3.
Further down though, one name stood out to me. It was Smiths Group (LSE:SMIN) – a FTSE 100 industrial company that I’d heard of, but never really looked into before.
I thought I knew it as the firm that makes airport detection equipment. But when I took a closer look, it turns out the firm’s actually looking to sell off this part of the business.
What’s left though, looks like a very interesting operation to me. I’m not convinced it fits Buffett’s criteria, but it’s one I’m interested in taking a closer look at for my portfolio.
Unlocking value
Smiths is currently a firm in transition. It’s divesting a couple of its major units – including the detection business – to focus on two of its two engineered components divisions.
The remaining operations concentrate on parts that are mission-critical and relatively inexpensive. And that can often be a formula that leads to some impressive unit economics.
When the cost of failure is high, customers are often willing to pay more to reduce the chances of this. As a result, suppliers are able to charge higher prices and maintain stronger margins.
The move to focus on these is partly a response to activist pressure. The idea is that focusing on the component businesses should get the stock trading above its current multiple.
Structure
I’m a big fan of industrial conglomerates as investments in general. And one of the things I’m always interested in is how they approach the question of decentralisation.
Operating through a central leadership team can reduce costs, but it can be slower in terms of decision-making. A decentralised model is faster, but it relies on more individual operators.
Smiths looks to combine the two. Back-office functions like HR, finance, and IT are done centrally, whereas decisions about how to implement the firm’s principles are made locally.
The firm looks to access the benefits of both, but the obvious danger is it could end up with each set of shortcomings. With the firm in transition, I’m interested to see how it goes.
Valuation
I don’t think Smiths Group meets Buffett’s investment criteria. Based on what I’ve heard in interviews with Todd Combs – a Berkshire Hathaway manager – it’s too expensive.
That said, I can see a lot to like about the firm and I’m interested in it for my portfolio. It has a business model I like very much and has worked well for a number of other companies.
I’m not sure yet whether I think it’s a better opportunity than some of the FTSE 100’s other industrial conglomerates. But I’m very happy to have it on my list for further research.
