Screening Stocks, Buffett-Style

By David Braverman Well, even a legendary investor can have an off year or two. That has been the case for Warren Buffett, as the stock of his company, Berkshire Hathaway (BRK.A

) underperformed the broader market in 2004, rising 4.3%, vs. 9% for the large-cap Standard & Poor's 500 index. The stock was something of a laggard in 2003 as well, posting a respectable increase of 16%, vs. the benchmark index's surge of 26%.

Of course, a soft patch of one or even two years must be placed in the context of the overall results of Buffett's remarkable career. 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 (see BW Online, 2/3/05, "Thinking Like Warren Buffett").

BOOK VALUE. Berkshire's book value per share has grown at a compounded annual rate of more than 20% over the last 38 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 $44 million today.

Buffett has prospered by buying quality stocks with good earnings power and hanging on through bull and bear markets. 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 S&P 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.

SOLID RETURNS. Over the years, the screen has put in a pretty good performance itself. In each of the past three years, the portfolio has outperformed the S&P 500 by 9.1% in 2002, 4.6% in 2003, and a whopping 13.4% in 2004.

Since its inception on Feb. 13, 1995, through Dec. 31, 2004, it had an average annual return of 17.8%, compared to 9.8% 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 S&P since inception:

Year

Screen Perf. (% chg.)

S&P 500 Perf. (% chg.)

*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

22.4

9.0

*From inception Feb. 13.

Many of the stocks from the previous update of the portfolio in August, 2004, also appear 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 sprinkling of technology and energy concerns made the list as well.

Here's 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 44 names:

S&P Promising Growth Portfolio -- February, 2005

Company

Ticker

Abbott Laboratories

ABT

Adobe Systems Inc.

ADBE

Ansys Inc.

ANSS

Apollo Group

APOL

Biomet

BMET

Brown & Brown

BRO

China Mobile Hong Kong

CHL

Citigroup

C

Cognizant Tech Solutions

CTSH

Cooper Cos.

COO

Dionex Corp.

DNEX

Eaton Vance

EV

Equifax

EFX

Equitable Resources

EQT

Factset Research Systems

FDS

Federated Investors

FII

First Data

FDC

Forest Laboratories

FRX

Glaxosmithkline

GSK

Harley Davidson

HDI

Impac Mortgage

IMH

Infosys Technologies

INFY

Intl. Game Technology

IGT

Johnson & Johnson

JNJ

Lincare Holdings

LNCR

Medtronic

MDT

Mylan Laboratories

MYL

New Century Financial

NEW

Novastar Financial

NFI

Novo Nordisk

NVO

Nuveen Investments

JNC

Occidental Petroleum

OXY

Paychex

PAYX

Plantronics

PLT

T. Rowe Price Group

TROW

SAP AG

SAP

SEI Investments

SEIC

Shuffle Master

SHFL

Sigma-Aldrich

SIAL

Strayer Education

STRA

Syntel

SYNT

Waddell & Reed

WDR

Waters Corp.

WAT

World Acceptance

WRLD

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

Numer de Guia, CFA, analyst for Standard & Poor's Portfolio Advisors, contributed to this article