Markets & Finance

Making Money Warren's Way


By David Braverman Bull market or bear, downturn or boom, one thing has remained constant over the past few decades: Warren Buffett's sterling track record. The legendary investor's company, Berkshire Hathaway (BRK.A

), has posted a compound annual return of around 22.3% over the last 36 calendar years. If you had invested $10,000 in Berkshire in 1965, your holding would be worth more than $50 million today.

How does he do it? In 1994, Robert Hagstrom wrote The Warren Buffett Way: Investment Strategies of the World's Greatest Investor, a book that attempted to codify the Sage of Omaha's winning strategies. Using Hagstrom's book as a springboard, we at Standard & Poor's have put together a stock screen that picks companies using criteria similar to Buffett's growth-oriented style of investing. S&P updates this screen on a semiannual basis, during the first week of both February and August.

STRONG RECORD. The screen has had a pretty fair track record itself. Overall, since its inception Feb. 13, 1995, through July 31, 2002, the screen stocks were up 169.3%, vs. a rise of 89.3% for the Standard & Poor's 500-stock index. (All performance figures are before dividends and transaction costs.)

Here's a closer look at how the screen portfolio has stacked up against the 500 since inception:

% Change

Year

Screen

S&P 500

*1995

31.4

27.9

1996

42.2

20.3

1997

11.5

31.0

1998

18.1

26.7

1999

18.0

19.5

2000

23.2

-10.1

2001

-5.6

-13.1

**2002

-19.9

-20.6

2/13/95-7/31/02

169.3

89.3

*From inception Feb. 13.

**Through July 31.

FOREIGN FLAVOR. Some of the stocks from the last update, in February, are still on hand in this edition. The new screen contains quite a few health-care and financial stocks, as companies in these sectors typically feature high margin and high return on equity -- key criteria for Buffett. And the screen has a bit of an international cast this time around, with five non-U.S. stocks on board.

To avoid stocks that are having only a temporary surge in profitability, S&P now looks for a return on equity above 15% for the most recent quarter and for each of the last three years.

The full criteria for this screen:

1. Owner earnings (cash flow less capital expenditures) above $20 million

2. Net margins of at least 15% for the trailing 12 months

3. Return on equity of at least 15% the previous quarter and in every year for the last three years

4. Retained earnings that have grown less than the market capitalization, on an absolute basis, in the last five years

5. Looking five years into the future, projected cash flow per share greater than the current market price for each stock (discounted to the present using the 30-year Treasury yield)

It should be noted that these are not necessarily stocks that Warren Buffett has bought or ever personally plans to buy. For example, the screen does not remove technology stocks although Buffett tends to avoid such issues (his recent investment in Level 3 Communications being a notable exception.) The list only reflects criteria that Buffett has emphasized in the past.

This time around, the screen turned up 33 stocks:

Adobe Systems (ADBE)

AmeriCredit (ACF)

Amgen (AMGN)

Apollo Group (APOL)

Barr Laboratories (BRL)

Barra (BARZ)

Brown & Brown (BRO)

Check Point Software (CHKP)

Citigroup (C)

Doral Financial (DORL)

Eaton Vance (EV)

First Health Group (FHCC)

GlaxoSmithKline (GSK)

Graco (GGG)

Guidant (GDT)

International Game Technology (IGT)

Investment Technology Group (ITG)

Johnson & Johnson (JNJ)

Eli Lilly (LLY)

Lincare Holdings (LNCR)

Microsoft (MSFT)

Novartis (NVS)

Orthodontic Centers Of America (OCA)

Pfizer (PFE)

PMI Group (PMI)

T. Rowe Price (TROW)

RenaissanceRe Holdings (RNR)

Sasol (SASOY)

SEI Investments (SEIC)

SLM (SLM)

Techne (TECH)

Total System Services (TSS)

UST (UST) Braverman is senior investment officer for Standard & Poor's


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