Markets & Finance

Getting on Warren's Wavelength


By David Braverman Perhaps no stock investor embodies the "buy and hold" strategy like Warren Buffett. While this approach -- buying quality stocks with good earnings power, and hanging on through bull and bear markets -- has fallen in and out of favor during the last few decades, the legendary investor has parlayed some well-chosen core holdings into an unparallelled track record (not to mention an enormous personal fortune). His company, Berkshire Hathaway (BRK.A), has posted a compound annual return in excess of 20% over the last 37 calendar years. If you had invested $10,000 in Berkshire in 1965, your holding would be worth more than $50 million today.

While it's doubtful an individual investor could ever totally replicate Buffett's success, his approach is well worth studying. Robert Hagstrom's 1994 best-seller, The Warren Buffett Way: Investment Strategies of the World's Greatest Investor, 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. S&P updates this screen on a semiannual basis, during the first week of both February and August.

STELLAR STATS. The screen has had a pretty fair track record itself. Overall, since its inception on February 13, 1995, through January 31, 2003, the screen had an average annual return of 15.76%, vs. 7.48% for the S&P 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

41.1

20.3

1997

11.5

31.0

1998

18.1

26.7

1999

18.0

19.5

2000

23.8

-10.1

2001

0.6

-13.1

2002

-12.7

-23.4

2/13/95-1/31/03

207.3

77.7

*From inception Feb. 13.

TECH INROADS. Some of the stocks from the last update, in August, are still on hand in this edition. It has less of an international flavor this time around, with fewer non-U.S. stocks on the roster.

The screen continues to feature quite a few health-care and financial stocks, as companies in these sectors typically feature high margins and high return on equity -- key criteria for Buffett. Some technology stocks have joined the list as well, including leading names Microsoft (home to Buffett's good friend and fellow billionaire Bill Gates) and Oracle.

And that brings us to our disclaimer. 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 tech stocks although Buffett tends to avoid such issues (his mid-2002 investment in Level 3 Communications being a notable exception). The list reflects only the criteria that Buffett has emphasized in the past.

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)

6. Market capitalization of $500 million or more

This time around, the screen turned up 25 stocks:

Promising Growth Stock portfolio -- February, 2003

Apollo Group (APOL)

Barr Laboratories (BRL)

Barra (BARZ)

Biomet (BMET)

Check Point Software (CHKP)

Citigroup (C)

Dassault Systemes (DASTY)

Deluxe (DLX)

Dionex (DNEX)

Eaton Vance (EV)

FactSet Research (FDS)

First Data (FDC)

First Health Group (FHCC)

GlaxoSmithKline (GSK)

Integrated Circuit Systems (ICST)

Investment Technology Group (ITG)

Johnson & Johnson (JNJ)

Lincare Holdings (LNCR)

Medtronic (MDT)

Microsoft (MSFT)

Oracle (ORCL)

Pfizer (PFE)

RenaissanceRe Holdings (RNR)

SEI Investments (SEIC)

SLM Corp. (SLM)

Braverman is senior investment officer for Standard & Poor's

S&P analyst Numer de Guia contributed to this article


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