Warren Buffett is widely regarded as the greatest investor of all time. The “Oracle of Omaha” has amassed a multi-billion dollar fortune through his holding company Berkshire Hathaway by following a disciplined, patient, value-based approach to investing. Since taking over Berkshire in the 1960s, Buffett has delivered compounded annual returns of over 20% for shareholders, far outpacing the broader market.
While Buffett hasn’t written his own book detailing his exact investment process, his former daughter-in-law Mary Buffett provided an inside look in her book “The New Buffettology”. Using the methodology Mary laid out, Validea has built a quantitative model that scores stocks based on the fundamental criteria most important to Buffett.
Validea’s Buffett-Inspired Model
Buffett looks for companies with strong, stable earnings growth, conservative financing, high returns on equity, and shareholder-friendly management. Here are the details behind the key criteria in Validea’s Buffett model:
- Earnings Predictability: 10 years of consistently increasing annual EPS with no losses
- Return on Equity: 10-year average ROE of at least 15%, with each individual year above 10%
- Return on Total Capital: 10-year average ROTC of at least 12% for non-financial firms
- Free Cash Flow: Positive free cash flow indicates the company is not overextending itself
- Use of Retained Earnings: Management is earning at least a 12% return on retained earnings
- Debt: Long-term debt no more than 5 times annual earnings
If a company meets these strict fundamental standards, Buffett then looks to buy at an attractive price based on long-term valuation. Validea calculates the expected annual return using both an earnings-based and book value-based approach. Stocks scoring above a 12% expected return pass Buffett’s demanding value criteria.
4 Stocks Scoring Highly on the Buffett Model
Several well-known large cap stocks currently earn top scores from Validea’s Buffett-based model. Here’s a look at these Buffett-type companies:
Apple Inc (AAPL): The world’s largest company with a market cap near $3 trillion, Apple designs and manufactures smartphones, computers, tablets, wearables and accessories. It has grown earnings 20% per year over the past decade with an average ROE of 84%. Apple passes all of Buffett’s key criteria.
Alphabet Inc (GOOGL): The parent company of Google, Alphabet dominates the online search market. It has delivered 28% annual EPS growth over the past 10 years with a stellar 26% average return on total capital. The stock earns a perfect score based on Validea’s Buffett approach.
Primerica, Inc. (PRI): This financial services firm provides term life insurance, mutual funds, annuities and other savings products to middle-income households. PRI has increased earnings in each of the past 10 years, has a strong balance sheet, and has a 22% return on equity. It passes the Buffett model with flying colors.
Lululemon Athletica Inc (LULU): An apparel retailer focusing on yoga and other fitness clothing, Lululemon has delivered outstanding fundamental performance. Earnings have grown 20% annually over the past 10 years and the firm has a 28% return on equity. With no long-term debt, positive free cash flow, and management earning a 22% return on retained earnings, LULU checks all of Buffett’s boxes.
Buffett’s Timeless Wisdom
While Buffett is famous for his witticisms like “be greedy when others are fearful” and “our favorite holding period is forever”, the true wisdom of Buffett lies in the consistency of his investing approach. For over half a century, he has focused relentlessly on strong businesses trading at attractive valuations. Trendy stocks or short-term trades have never interested him.
That commitment to a proven, fundamentals-based strategy is deeply embedded in the Buffett model Validea has built. The model ignores the day-to-day noise of the market and instead systematically selects stocks meeting Buffett’s timeless investing principles. As long as there are high-quality companies available at reasonable prices, Buffett’s wisdom and techniques will remain highly relevant to investors.
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