Why Did Warren Buffett Buy More Shares of This Healthcare Company?

In a Form 3 filing issued with the SEC earlier this morning, Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) disclosed that it now owns more than 10% of dialysis services provider DaVita Inc. (NYSE:DVA). The move increased Buffett’s total holdings of DaVita to 10.2 million shares, with the most recent transaction amounting to little over 280,000 shares worth $29.7 million. The “Oracle of Omaha” now holds a whopping $1.1 billion in DaVita stock. Here’s a complete look at Warren Buffett’s holdings.

Warren BuffettIn early morning trading following the release, shares of the company were up almost 1.5%. Before you write off these gains as purely speculative, it’s important to remember that empirical studies have proven that individual investors who mimic or “monkey,” the world’s most successful hedge fund managers can beat the market by 7 percentage points a year. Therefore, it’s worth looking into a potential motive behind Buffett’s bullish DaVita bet.

Since the start of 2012, DaVita has been a solid investment, returning 37.8%. This appreciation has outpaced the medical care industry’s average (23.8%), and competitors Baxter International Inc. (NYSE:BAX) at 22.6%, and Fresenius Medical Care AG & Co. (NYSE:FMS) at 10.3%. Over this same time, DaVita has reported generally impressive earnings, beating the Street’s estimates in three straight quarters. This streak is longer than that of Baxter, which has beat analyst forecasts in two straight quarters, but below similarly-sized peers like Fresenius, HCA Holdings Inc (NYSE:HCA), and Tenet Healthcare Corporation (NYSE:THC).

In its most recent earnings release, DaVita reported an EPS of $1.49, beating consensus by 2 cents, even though the company experienced larger than expected second quarter losses related to its international expansion efforts. CEO Kent Thiry called the period “rock-solid,” claiming that his company “perform[ed] well clinically, operationally and strategically.”

Part of DaVita’s international expansion plan includes partnering with medical organizations in Southeast Asia, Europe, and the Middle East to bring affordable dialysis care to patients of all nationalities. Most of the company’s costs related to this activity stems from the legal and professional service fees needed to close the deal on partnerships and acquisitions. These expenses totaled $12 million in the past quarter, and the company expects to lose $30 million by the end of this year, though execs state “international expansion is a long-term growth activity, it will require … continued losses in the short term.”

Most likely, Buffett is optimistic that these expansion plans will help DaVita generate solid earnings appreciation going forward. Early estimates expect the company to average EPS growth of 12.3% a year over the next half-decade. This is decidedly more impressive than its aforementioned competitors, as Baxter (8.5%), Fresenius (10.5%), HCA Holdings (10.9%), and Tenet Healthcare (12.2%) all have lower expected EPS growth.

From a valuation standpoint, we can see that investors are not overpaying for DaVita’s earnings potential, as the company’s stock sports a PEG ratio of 1.54; typically any figure between 1 and 2 indicates shares are trading at a fair price. More interestingly, DaVita is actually cheaper than the likes of Baxter, Fresenius and Tenet Healthcare, which trade at an average PEG of 2.36. Only HCA Holdings, which trades at a PEG of 0.48, is a better value.

One final point worth mentioning is that DaVita appears to have the first step on its competitors due to its advantageous operational efficiency. Over the past twelve months, the company has averaged operating (16.1%) and net (6.9%) margins far above the industry averages (12.4%, 4.3%), indicating that Buffett is most likely a fan of DaVita’s superior cost-saving abilities.

While DaVita is expecting double-digit earnings expansion in a time when the majority of other companies operating in the medical care industry are predicting much less, the biggest reason to be bullish on this stock is that investors can truly buy growth at a reasonable price. Despite DaVita’s gains in 2012 thus far, valuation indicators suggest that more appreciation may be on the horizon, and a boost from Warren Buffett is never a bad thing.

Other fund managers that currently hold DaVita are Andreas Halvorsen’s Viking Global, Stephen Mandel, and Lee Ainslie, though Buffett owns more than twice the number of shares as the next closest fund. For a complete look at the hedge fund industry’s sentiment toward this stock, continue reading here.

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