Applying the Oracle of Omaha's Wisdom


By David Braverman, CFA Warren Buffett is back in familiar territory: beating the market. After underperforming the Standard & Poor's 500-stock index in 2003 -- posting a respectable gain of 16%, vs. the benchmark index's surge of 26% -- the stock of Buffett's company, Berkshire Hathaway (BRK.A

; recent price: $85,700), has pulled ahead of the 500 thus far in 2004 (through July 30), rising 3.6% vs. the index's decline of 0.9%. S&P analyst Catherine Seifert says Berkshire stock has outperformed as investors continue to support Buffett's investing philosophy. Still, there is some concern that the shares may be fully valued and that price competition could heat up in the property-casualty insurance business, she says.

Buffett has prospered by buying quality stocks with good earnings power and hanging on through bull and bear markets. During the last few decades, he has parlayed some well-chosen core holdings into an unparalleled performance record (not to mention an enormous personal fortune). Berkshire's book value per share has grown at a compounded annual rate of more than 20% over the last 37 calendar years. If you had invested $10,000 in Berkshire in January, 1968 (the shares closed at $20.50 on the last trading day of that month), your holding would be worth more than $41 million today.

What could an individual investor learn from Buffett's methods? Author Robert Hagstrom tried to compile Buffett's key investing strategies in his 1994 best-seller, The Warren Buffett Way: Investment Strategies of the World's Greatest Investor. With Hagstrom's book as a source, we at Standard & Poor's have put together a stock screen that picks companies using criteria similar to those that fit the legendary investor's growth-oriented style. S&P updates this screen on a semiannual basis: during February and again in August.

Over the years, the screen has put in a pretty good performance itself. Since its inception on February 13, 1995, through July 30, 2004, it had an average annual return of 16.5%, vs. 9.2% for the S&P 500. (All performance figures are before dividends and transaction costs.)

Here's 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

2003

31.0

26.4

2004 (through July 30)

3.4

-0.9

*From inception Feb. 13.

Many of the stocks from the previous update of the portfolio, in February, 2004, are present in this edition. The screen continues to harbor quite a few health-care and financial shares, as companies in these sectors typically feature high margins and high return on equity -- key criteria for Buffett. Once again, a number of technology and energy concerns made the list as well.

And now for our disclaimer. It should be noted that these are not necessarily stocks that Buffett has bought or ever personally plans to buy. 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.

The current version of the screen lists 46 names.

Promising Growth Stock portfolio -- August, 2004

Adobe Systems (ADBE)

Anglogold Ashanti Ltd. - ADR (AU)

Apollo Group Inc. (APOL)

Biomet Inc. (BMET)

Block H & R Inc. (HRB)

Brown & Brown Inc. (BRO)

Catellus Development Corp. (CDX)

China Mobile Hong Kong - ADR (CHL)

Citigroup Inc. (C)

Cognizant Tech Solutions (CTSH)

Eaton Vance Corp (EV)

Equitable Resources Inc. (EQT)

Factset Research Systems (FDS)

Federated Investors Inc. (FII)

First Data Corp. (FDC)

Forest Laboratories (FRX)

GlaxoSmithKline PLC - ADR (GSK)

Graco Inc. (GGG)

Harley-Davidson Inc. (HDI)

Impac Mortgage Hldgs Inc. (IMH)

Infosys Technologies - ADR (INFY)

Intl Game Technology (IGT)

Johnson & Johnson (JNJ)

Lincare Holdings Inc. (LNCR)

Medtronic Inc. (MDT)

MEMC Electonic Materials Inc. (WFR)

Mylan Laboratories (MYL)

New Century Financial Corp (NCEN)

Nextel Communications (NXTL)

Novartis AG - ADR (NVS)

Novastar Financial Inc. (NFI)

Novo-Nordisk A/S - ADR (NVO)

Occidental Petroleum Corp. (OXY)

Par Pharmaceutical Cos Inc. (PRX)

Paychex Co. (PAYX)

Plantronics Inc. (PLT)

Price (T.Rowe) Group (TROW)

Renaissancere Holdings Ltd. (RNR)

SAP AG - ADR (SAP)

SEI Investments (SEIC)

SK Telecom Ltd - ADR (SKM)

SLM Corp. (SLM)

Strayer Education Inc. (STRA)

Syntel Inc. (SYNT)

UnitedGlobalCom Inc. (UCOMA)

Waters Corp (WAT)

Braverman is vice-president for Standard & Poor's Portfolio Advisors

Numer de Guia, CFA, and Michael Kaye, CFA, analysts for Standard & Poor's Portfolio Advisors, contributed to this article


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