A Birthday Gift Buffett Would Truly Appreciate

What do you get an octogenarian billionaire investor for his birthday? That's a question that Warren Buffett's friends and family are asking themselves today. We humbly submit that the best gift may be a smaller pool of assets to invest. 

Buffett himself has said many times that the biggest challenge he faces in keeping up his remarkable track record is deploying his massive and growing amount of capital. It's not that the Oracle of Omaha has suddenly lost his confidence in picking stocks or making other investments. There just aren't very many attractively priced deals or stocks out there that are large or liquid enough to move the needle. The only way to really make a difference is with megadeals, such as the purchase of Burlington Northern Santa Fe, that are both sizable and have the ability to soak up the huge amounts of cash that Berkshire throws off. Such transactions just don't come along that often. 

Our Berkshire analyst Gregg Warren illustrates the scale of this problem in his Premium Analyst Report for Berkshire. In 2013, the firm spent over $18 billion to acquire everything from a stake in Heinz to NV Energy. Yet, it started and ended the year with the same amount of cash--about $42 billion. That number has only climbed higher in 2014. Even after accounting for the $20 billion in cash Buffett says he likes to have on hand as a buffer for the insurance business, the firm is still sitting on a vast amount of excess cash. 

The problem isn't that Buffett is not looking--he has said that his elephant gun is ready to bag a big target, and he almost certainly is looking at options every day. Some may be rejected because valuations are too high today. But Buffett has indicated that he is not afraid to pay up for a high-quality business, so that can only be a partial explanation. It's likely that many potential investment options just aren't big enough to be worthwhile at his level. (It is worth nothing that Todd Combs and Ted Weschler, who manage smaller but growing pools of money at Berkshire, are more likely to buy shares in smaller firms, as are Berkshire subsidiaries buying businesses for strategic reasons.) 

Of course, there are worse problems to have than a successful business that produces so much cash you don't know what to do with it. And size and clout do have their advantages. Just this week, Buffett was able to invest $3 billion in preferred equity in Burger King's buyout of  Tim Hortons . This is just the latest in a series of deals where Buffett has been able to extract good terms in exchange for giving his stamp of approval to a deal. During the financial crisis, he was able to use the power of his strong balance sheet to make loans at very attractive rates to firms such as  Bank of America (BAC) and  Goldman Sachs (GS), which ended up paying off handsomely for him.  

You may not be able to give Buffett the gift of being more flexible in what he can buy, but as an individual investor you may be able to give yourself a gift by taking advantage of firms that he might like to invest in--if only they were big enough. These are high-quality firms, with lasting competitive advantages, that will keep producing an economic profit for years to come.

With the market regularly hitting record highs and valuations looking stretched, there aren't a huge number of bargains, but there still are a few firms that are trading at reasonable valuations. To find some of these stocks, we used our Premium Stock Screener. We looked for 4- or 5-star-rated, wide- or narrow-moat stocks with a market cap of less than $10 billion. Below are three firms that passed. Click  here to run the screen yourself.

 Core Labs (CLB)
Star Rating: 4 | Moat: Wide | Market Cap: $6.9 Billion
From the Premium Analyst Report:
We believe that Core Lab's moat is as wide as they come. The company's three-year historical average return on invested capital (including goodwill) of 50% is currently the fifth highest of the more than 200 wide-moat companies we follow. The primary source of Core's wide moat is its intangible assets. Working with clients to improve reservoir recoveries in oilfields around the globe, the firm has accumulated decades of geologic data, built considerable knowledge within its workforce, and developed numerous proprietary processes and products. We believe these intangible assets translate into a level of expertise that customers increasingly recognize as valuable and which will continue to create new opportunities for additional work.

 Catamaran
Star Rating: 4 | Moat: Narrow | Market Cap: $9.8 Billion
From the Premium Analyst Report:
Catamaran is the third-largest pharmacy benefit manager, with over 250 million adjusted claims processed in 2013. The firm was recently formed through the merger of PBM information technology provider SXC Health Solutions and pure-play PBM Catalyst Health Solutions. We believe the new entity is very beneficial to investors, as Catamaran's combined claim volume should produce solid economic profits over an extended period. As a result, we award the firm a narrow economic moat rating.

 TIBCO Software
Star Rating: 4 | Moat: Narrow | Market Cap: $3.4 Billion
From the Premium Analyst Report:
TIBCO has built a successful narrow-moat business by being an independent provider of infrastructure software; we believe its expansion into data discovery and business-intelligence products is a natural evolution of its business-application-centered products. The firm has seen strong growth from its Spotfire analytics/big data product, while its core middleware and application infrastructure products remain customer favorites.

Data as of Aug. 28, 2014.