What's surprising now is the sheer number of large companies that qualify (the screen is shown in detail in the box below). Traditionally only a few companies pass the first quantitative stage and even less pass the second crucial qualitative stage – where you're looking for some unique competitive position.
Twelve companies pass the test at the moment, ranging from big pharma companies to platinum miners.
The companies that stand out are the really big ones, producing mountains of cash with great market positions. AstraZeneca is a good example – here's a company that no one today could really afford to build up via acquisition, yet is in a sector facing long-term structural changes. Crucially its intellectual property is the source of its huge cash-generating position.
Mr Buffett would probably also like the prodigious cash-generative power of multi-utility Centrica, especially as it boasts a regulated market position. Next is a clear bet on a brand – currently humbled by the downturn in consumer spending, but a pre-eminent brand nevertheless, although Mr Buffett might prefer a slightly less flamboyant brand such as Dunelm, an East Midlands-based home furnishings and linen retailer which is precisely the kind of company he likes – low profile, focused on margins, producing cash and humble about its powerful brand in the market place.
Another company that Mr Buffett might really take a fancy to is Bodycote. This industrial services and specialist industrial metals/chemicals outfit is supremely well run and has a great global market position with a strong technology-induced competitive moat around the business. We also think that he would like plastics products and cigarette filters company Filtrona, which has a sound balance sheet, is producing plenty of cash and should benefit from falling oil prices. Mr Buffett likes strong companies in boring sectors with a great balance sheet and motivated management, and Filtrona fits that bill.
Our screen in detail ■ Market capitalisation more than £250m, ■ Dividend yield more than 4 per cent ■ Return on capital employed more than 15 per cent ■ Return on capital employed increased in last year ■ Interest cover more than 1.5 ■ Net gearing less than 50 per cent ■ Positive cash flow and growing in past year ■ PE ratio under 15 ■ Operating profit margin above 5 per cent and growing year on year ■ Cash flow per share greater than earnings per share ■ Exclude all companies with ratio below 1 |
The Buffett basics Warren Buffett is perhaps the most famous living investor – he's certainly one of the most successful. That investing prowess and his almost legendary status, is in no small part due to his extensive use of stock screening, which has delivered huge profits for investors in his Berkshire Hathaway group. Book value per share in Berkshire has grown at a compounded annual rate of more than 20 per cent over the past 37 calendar years. What's even more surprising is that screens based on his ideas also seem to work. Analysts at S&P/Business Week have been running a Buffett screen since February 1995 – over the past nine years the screen has delivered an average annual return of 17.7 per cent, against 9.9 per cent for the S&P 500. Precisely because he doesn't spell out his criteria or likely investment targets (that is, after all, how he makes his money) it's left to his prophets to detail the gospel according to Mr Buffett. Two schools dominate. The first are the Buffettologists, led by Warren's former daughter-in-law, Mary, and his old friend and colleague David Clark. The rival camp is led by Robert Hagstrom, the author of three popular books on Mr Buffett, including 1994 bestseller The Warren Buffett Way: Investment Strategies of the World's Greatest Investor . They articulate a classic Buffett philosophy – take your time to find the right stock, use painstaking research and screening, and then stick with the share until its intrinsic value is realised. As Mr Buffett would say: "Buy great companies, not great stocks." That means you should approach buying a single share as if you were buying the entire business. At the heart of Mr Buffett's analysis is his dislike of what he calls commodity-based companies, where price is king and the cheapest firm and products always wins out. Such companies are characterised by low profit margins, low returns on equity, little brand loyalty, excess capacity within the industry and erratic profits. Consumer monopolies, on the other hand, are very much Mr Buffett's forte. He likes companies with significant pricing power, partly through strong brand recognition or significant intangible but unrecognised value. These 'monopoly' firms can easily build shareholder value by making the 'intrinsic value' in the company more open. |
