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Stock Screen: Buy 'Em Like Buffett

S&P's latest screen tracking the Berkshire Hathaway honcho's investing criteria turns up 49 attractive names

From Standard & Poor's Equity ResearchFrom S&P Index Services (which operates separately from S&P Equity Research)

Warren Buffett has earned a reputation as one of the preeminent value investors of all time. His Berkshire Hathaway (BRKA) holding company has stakes in insurance, publishing, retailing, and manufacturing, among other businesses, and more than $28 billion of cash on hand, in addition to $102 billion of securities.

But like others in the financial services industry, Berkshire Hathaway has fallen on troubled times. Its second-quarter earnings report, posted in mid-August, showed a 7.5% decrease in earnings from the year-earlier period, mostly the result of a 43% drop in underwriting profits and a mere 2.6% rise in investment income. In that report, Buffett disclosed he had purchased, for Berkshire's investment portfolio, a new stake in NRG (NRG), and added to already existing stakes in Sanofi-Aventis (SNY) and Ingersoll-Rand (IR).

But how does Buffett make his picks? What exactly is "Warren's Way?" In his rare public remarks and widely followed annual letters to Berkshire shareholders, Buffett makes it sound very simple: He says he buys stocks that are "available at a sensible price."

In fact, Buffett uses sophisticated screens to determine which companies belong in his portfolio. Specifically, he uses these five investment criteria:

Free cash flow ( net income after taxes, plus depreciation and amortization, less capital expenditures) of at least $250 million.

Net profit margin ( of 15% or more.

Return on equity (> of at least 15% for each of the past three years and the most recent quarter.

A dollar's worth of retained earnings ( creating at least a dollar's worth of shareholder value over the past five years.

Ample liquidity. Only stocks with a market capitalization ( of at least $500 million are included.

In the Standard & Poor's "Warren Buffett" screen, we've added one more criterion to eliminate overvalued stocks. Overpriced stocks are identified by comparing our five-year discounted cash flow (DCF) ( estimate with the current price.

Forty-nine names emerged (, 9/5/08) when the screen was completed.

It is important to note that these are not stocks that Buffett has purchased or announced plans to purchase. They are simply stocks that meet the criteria that Buffett has emphasized in the past. It is relevant to note that many of the huge (billions of dollars) charges taken by financial institutions over the last three quarters have had a minimal impact on their cash flow, since they represented a paper writedown to portfolios compared with the actual sale (such as Merrill Lynch (MER) announced). In adding the S&P DCF requirement, several financial issues dropped out, which appears to fit well with Buffett's current stance on the approach.

See the slide show (, 9/5/08) to learn more about the top 25 companies by market cap.

Business Exchange related topics:

Warren Buffett

Berkshire Hathaway

U.S. Stock Market

Stock Research

Investing in Growth Stocks

Howard Silverblatt is Standard Poor's senior index analyst for its Index Services unit. In addition to general market research and commentary, he is responsible for the statistical analysis of Standard Poor's family of U.S. indices -- including the world's most recognized index, the SP 500.

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard Poor's Regulatory Disclosure

Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard Poor's" reflect the views of Standard Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard Poor's. Standard Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.

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