Validea’s Warren Buffett model using published writings about Buffett to identify stocks that might meet his fundamental tests. The strategy aims to identify high-quality companies with predictable earnings that are trading at attractive prices.
The strategy has two main stages:
Stage 1: Identifying “Buffett-type” companies
- Look for companies with strong brand recognition or “consumer monopolies”
- Seek predictable earnings – no negative EPS in the past 10 years (with some exceptions)
- Conservative financing – long-term debt should be payable from 5 years of earnings or less
- High return on equity (ROE) – 10-year average ROE of at least 15%
- High return on total capital – 10-year average of at least 12%
- Positive free cash flow
- Good use of retained earnings – at least 12% return on retained earnings
Stage 2: Determining if the price is attractive
- Initial rate of return (earnings yield) should be higher than the 10-year Treasury bond yield
- Calculate expected return using two methods:
- ROE method – project equity growth and earnings over 10 years
- EPS growth method – project EPS growth over 10 years
- Average the two expected returns – should be at least 12%, preferably 15% or higher
The model aims to replicate Buffett’s patient, value-oriented approach of buying great businesses at good prices and holding for the long-term. It emphasizes predictable earnings, strong competitive advantages, conservative financials, and management that allocates capital effectively to generate high returns for shareholders. While it cannot fully capture Buffett’s qualitative insights, it provides a systematic way to apply core principles of his investing philosophy.
Here are the top ten highest scoring stocks for July 2024 for Validea’s Patient Investor strategy based on Buffett.
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