Buffett Watch

Cooking Up Warren Buffett-Style Stock Picks

Can you create a cookbook for investing using the recipe for success created by "Chef" Warren Buffett?  Standard and Poor's Quantatative Services has been doing it for more than 12 years and has served up some tasty results.  (Sorry about all the food references.  I must be hungry.) 

The number crunchers at S&P have created a stock screen that "picks companies similar to the legendary investor's growth-oriented style."  The screen uses 'ingredients' distilled from Robert Hagstrom's 1994 book The Warren Buffett Way: Investment Strategies if the World's Greatest Investor.

Twice a year, in February and August, a computer goes through the entire universe of stocks looking for these six criteria, as listed in BusinessWeek's A World of Winners, Warren's Way (both S&P and BusinessWeek are owned by McGraw-Hill, although they operate separately):

1. Owner earnings (cash flow less capital expenditures) of at least $250 million (changed in August, 2007, from $50 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); this helps remove overpriced stocks from the list

6. Market capitalization of $500 million or more

The result is the S&P Promising Growth Portfolio.  This time around it contains 55 stocks including "a generous sampling of health-care, consumer-products, and technology outfits."  S&P also points out a "growing number of European and Asian names."  (The Times of India somewhat proudly reports that three of the companies on the list, Infosys, Wipro and Satyam Computer, are based in that country.)

Does the recipe work?  S&P says, "Since its inception on Feb. 13, 1995, through July 31, 2007, the screen has had an annualized return of 15.69% vs. 9.28% for the Standard & Poor's 500-stock index."

Is Warren Buffett following this exact recipe?  Absolutely not.  S&P notes the stock screen's results 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."


Remember the Warren Buffett quote at the center of the WBW post last week entitled Warren Buffett and the Perils of Swimming Naked?

"It's only when the tide goes out that you learn who's been swimming naked."

It gets another workout from Dan Roberts, the Sunday Telegraph's Business Editor in Don't plunge back in until Warren says it's Safe.  Roberts takes it a bit further, imagining Warren "standing on the beach with a year's supply of spare swimwear ready to cash in at the moment of maximum discomfort."  That is, buying the bonds of solid companies at a discount as a "lender of last resort."

Questions?  Comments?  Email me at buffettwatch@cnbc.com