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Pick Stocks the Buffett Way — Without the Billions

By    |   Tuesday, 08 Apr 2008 01:55 PM

Warren Buffett has billions of dollars to invest and needs to limit his stock selections to companies with enough size to make a difference in his portfolio.

Most individual investors have a great deal of flexibility and can buy stocks of any size. We applied Buffett's method to small and mid-cap stocks and found ten stocks that he'd probably like if he were just starting out.

Small, local banks dominate the list. These are an example of stocks that have been beaten down because of larger trends. Local bankers, like Jimmy Stewart in "It's a Wonderful Life," are potential beneficiaries of changes in the mortgage market.

As regulation increases nationally, the local banker will be in the best position to gauge risk and get the deals done. Buffett has been active in the municipal bond market, another financial minefield with companies of enough size to make it worth his time.

But his inability to invest in small banks may be thought of as an opportunity for small investors.

The criteria are:

-Market cap of $1 million to $2 billion

-Price to earnings (P/E) ratio of less than 25.7 — based on Buffett's writings that stocks should be priced in line with the yield on long-term Treasuries. A 3.5 percent yield on the 10-year Treasury is equivalent to this P/E ratio plus a 10 percent margin of safety. Buffett doesn't add a margin of safety, but we want to be more conservative.

-Positive earnings growth for the past five years

-Return on equity (ROE) greater than 15 percent — Buffett considers this to be a good measure of management effectiveness.

-Profit margins greater than the industry average — another margin of safety to ensure that the company should continue making money in an economic downturn.

-Debt lower than the industry average

-Fewer than 1,000 employees — to make sure that only small companies make the cut rather than large companies that fell on hard times and are in the midst of a turn around

Using these criteria, here's a superstar screen that builds a Buffett-style portfolio. Remember, these are long-term ideas.

Bridge Capital Holdings (BBNK)

This small California bank is growing faster than its competitors. Analysts confirm the screen and are looking for minimum price appreciation of 25 percent. Shares recently traded at $21.19.

Great Southern Bancorp, Inc. (GSBC)

Insiders own almost a third of this company, representing a strong vote of confidence in its future. The dividend yield — 4.68 percent with the stock at $15.39 per share — is easily covered by earnings per share estimated at $1.80 this year and $2.20 next year.

Hittite Microwave Corporation (HITT)

This high-tech stock might not be on Buffett's radar because the business is difficult to understand. But the opportunity in wireless communications is unlimited, the fundamentals are solid, and HITT is an industry leader. Recent price: $36.63 per share.

Mackinac Financial Corporation (MFNC)

Mackinac is a Michigan bank with a 35-year operating history, growing slowly in a battered economy. Its P/E ratio of merely 3 prices in a lot of bad news: Earnings are expected to fall from $0.60 per share last year to $0.40 this year and rebound to $0.80 next year. At a recent price of $9, MFNC is a low-risk buy.

Preferred Bank (PFBC)

This is another small California bank with a sound balance sheet. Closing at $16.71 a share recently, PFBC offers a P/E ratio of 6.7, a dividend yield of 4 percent, and estimated earnings growth in line with the industry average. It's thinly traded, so use a limit order to enter the trade.

S&T Bancorp, Inc. (STBA)

S&T is a Western Pennsylvania-based bank with operating margins twice the industry average. Analysts are projecting slow but steady growth and earnings easily cover the dividend yield of 3.80 percent, based on a recent price of $31.60 a share.

Suffolk Bancorp (SUBK)

This is a well managed bank in New York, founded in 1890. It has a recent price of $31 per share, P/E ratio of 15, and secure dividend yield of 2.70 percent.

Trico Marine Services Inc (TRMA)

A safe way to invest in oil, TRMA provides services to offshore oil rigs. A small player in an industry filled with giants, the stock is trading near $38.80, and has a P/E ratio under 10, a little more than half the industry average. Steady earnings growth of 15 percent over the past five years is likely to continue into the future.

WestAmerica Bancorp. (WABC)

Yet another California bank with earnings of $3.00 a share. Its above-market P/E ratio of 18 recognizes value in a company with a 2.60 percent dividend and growing earnings. Recent close: $51.22

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MichaelCarr
Warren Buffett has billions of dollars to invest and needs to limit his stock selections to companies with enough size to make a difference in his portfolio.Most individual investors have a great deal of flexibility and can buy stocks of any size. We applied Buffett's...
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Tuesday, 08 Apr 2008 01:55 PM
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