Billionaire Bill Ackman has nearly 20% of his portfolio in a magnificent travel stock

Bill Ackman is one of the most watched investors of the 21st century. The billionaire and manager of the over $10 billion hedge fund Pershing Square adopts a Warren Buffett-style investment strategy. He aims to build a concentrated portfolio of high-quality stocks that he can hold for many years.

Many of Ackman’s stock positions represent more than 10% of his portfolio. One stock he has held since 2018 is Hilton hotels (HLT 0.62%). The stock is up nearly 200% since the start of 2018, and now represents 18.5% of Pershing Square’s portfolio.

Here’s why Ackman may be attracted to the famous hotel brand, and why the stock is a perfect play on the growth of global travel.

A trusted hotel brand and acceptance rate for global travel

The Hilton hotel brand is almost 100 years old. Started in Texas, it set out to provide a luxury hotel experience and build a trusted brand for travelers. Today, the brand is as strong as ever, but the business model has changed slightly. Rather than owning all of its hotels outright, Hilton licenses its brand to property owners. The owners put in all the capital investment, making Hilton an equity-light model that simply licenses Hilton to these properties.

By bringing hotels into the Hilton system, owners sacrifice a percentage of the spend for each property that is reimbursed to Hilton for franchising the brand. However, owners appreciate this because of the trust built into Hilton. If you license the Hilton brand, you generally get higher occupancy rates and can increase your room prices. This offsets the license fee paid to the Hilton Corporation each year. Win-win for both parties.

Hilton’s franchise strategy acts as an increasing take-up rate of global travel. The company is constantly adding new hotel rooms through acquisitions (it recently added the Graduate hotel brand, for example) as well as organic development for new properties. Last quarter, it had 18,000 net room additions worldwide. In addition to this increase, Hilton earns more from hotel room price inflation. Revenue per room is expected to grow 2% to 3% on average this year.

That’s how Hilton generates $10.8 billion in annual sales, along with $2.34 billion in operating income. The combination of the increase in hotel rooms and the increase in prices leads to a greater flow of money in license fees to the parent corporation Hilton.

The outflow returns with share buybacks

With all the cash flowing to the balance sheet and little need for capital investment (remember, the owners build the hotels for Hilton), the company has plenty of excess cash to return to shareholders.

Management’s preferred method of return on capital is share buybacks. This reduces the outstanding shares of the stock, increasing the ownership of existing shareholders such as Bill Ackman. Over the past 10 years — even with a break during the COVID-19 pandemic — Hilton has reduced its share count by 25%, making it one of the best buybacks on the public markets. This will help juice returns for existing shareholders in the long run.

HLT distributes outstanding YCharts data

Are stocks bought today?

Based on last quarter’s guidance, Hilton’s management expects the company to generate earnings per share (EPS) of just over $6 in 2024. With a share price of $232.91, that puts the stock at a forward price-to-earnings ratio ( ON). ) of 38.8, which is much higher S&P 500 index average of 29. Hilton shares are up 60% over the past year, and the P/E ratio has risen along with it.

In fact, this is one of the highest forward P/Es that Hilton has ever traded at. At the start of 2023, the stock had a forward P/E of nearly 20, which is much more acceptable for a mature business.

If you own Hilton stock, there’s no reason to rush to sell because of an extended valuation. Business is going well. But I think any potential investor would be wise to keep the stock on their watch list for now. Buying at a P/E of 38.8 for a low-growth business doesn’t make much sense, and such a high P/E makes the stock risky for investors to buy today.

Avoid adding Hilton stock to your portfolio for now.