The surest way to become rich in the market is to buy quality businesses, get out of the way, and let them do the heavy lifting for you. Few embody this mindset better than Berkshire Hathaway's (BRK.A 0.36%) (BRK.B 0.21%) chairman and chief executive officer, Warren Buffett.
As a result of this simple investing strategy, the Oracle of Omaha has become one of the most successful investors of all time. That's why investors seeking success would be remiss to ignore the holdings in Berkshire Hathaway's $346 billion portfolio.
RH (RH 0.19%), formerly known as Restoration Hardware, is one of the more interesting investments by Buffett's holding company, which owns a 9.9% stake that's worth $661 million. Let's drill down into what Buffett likes about RH to better understand why it is a buy for long-term investors.
A winning business model with room to grow
It's not a secret that Warren Buffett aims to fill Berkshire Hathaway's portfolio with companies that have wide moats, a category into which RH fits. The luxury home furnishings company appeals to a customer base with incomes well into the six figures and beyond. While economic downturns hurt everybody on the income spectrum, high earners are often the least affected. This makes RH relatively resilient against a recession.
The company attracts leading designers and manufacturers, which is what differentiates its products from those of competitors. This builds on its reputation among high-end customers for having elegant taste, which explains the company's moat.
And due to RH's competitive advantages, customers don't mind paying more for its products. This is how the company logged 24% operating margins over the last year -- 50% higher than the industry average of 16%.
Given RH's significant brand appeal and profitability, the company arguably has a bright future. Its 120 galleries, outlets, and showrooms as of July 30 are just scratching the surface. With ambitions to open design galleries in every major market in the world, RH estimates that its annual revenue could reach $20 billion to $25 billion. Against the $3.6 billion in revenue that analysts are expecting in 2022, this is tremendous upside potential.
Image source: The Motley Fool.
The company is financially strong
Without the financial means to expand, RH's growth ambitions are rendered meaningless. Fortunately, the company should easily be able to fund its visions of branching out to hundreds more major markets around the world.
This is because through July 30, the first half of its fiscal year, RH had generated $192.5 million in operating cash flow. Even with the $62.6 million in capital expenditures during this time to open more galleries, the company recorded $130 million in free cash flow. Along with the fact that RH doesn't pay a dividend, this excess cash is further fortifying its financial position to withstand any near-term consequences of a potential global recession.
A wonderful business worthy of a greater valuation
Shares of RH are down 48% year to date, which is an excessive sell-off given the company's built-in competitive advantages.
This has pushed RH's forward price-to-earnings ratio down to just 11.7, which is in line with the average multiple of 11.4 for the luxury-goods segment of the S&P 500. The company enjoys far higher profitability than its competitors, which is why I believe the market's haste is a great Christmas present for investors looking to buy shares of this wonderful business.
