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Learning From Buffett's Latest Buys

By    |   Wednesday, 19 November 2008 03:55 PM

Warren Buffett needs no introduction. Once again ranked by Forbes as the world's richest man, his stock-picking skills remain second to none.

A study called "Imitation is the Sincerest Form of Flattery" shows that following in the footsteps of the investment legend can be almost as profitable as directly owning Berkshire Hathaway, Buffett's investment company.

The Securities and Exchange Commission requires large investors like Buffett to disclose their stock holdings on a quarterly basis. These filings can be used to determine buys and sells, and gain insight into the thinking of the Oracle of Omaha.

Gerald Martin of American University and John Puthenpurackal of the University of Nevada-Las Vegas found that you could have beaten the S&P 500 by more than 10 percent a year from 1976 to 2006 simply by buying the stocks Buffett owned after he announced his initial purchases.

Of course, Buffett himself did even better over that time span. The stock portfolio of Berkshire Hathaway gained an average of more than 30 percent a year over those three decades, more than twice as much as the S&P 500 gain of 14 percent a year.

In his latest quarterly filing, Buffett revealed that he had increased his stakes in oil company ConocoPhillips and natural gas company NRG Energy. He also bought more of US Bancorp and purchased shares of hydraulics manufacturer Eaton.

I used this filing as the starting point to develop this week's screen. Studying the characteristics of these purchases led to the following criteria:

  • A market capitalization of at least $5 billion. This is a little smaller than stocks that we usually find Buffett investing in.

  • A P/E ratio less than the industry average, and a return on equity greater than the industry average. This identifies undervalued companies with good management.

  • Better than average cash flow, since Buffett seems to value cash flow more than anything else when evaluating potential investments.

    Only nine companies met these criteria, and they have an average P/E ratio of only 7.

    Baker Hughes (BHI) is an oilfield services company. Earnings growth and cash flow have both increased by nearly 50 percent a year over the past five years. Earnings growth is expected to slow to 10 percent next year, but the market seems to have adequately priced this into the stock. Recently trading at 32.05, BHI has a P/E ratio of only 6, less than half the market average.

    Chevron (CVX) is the type of household name Buffett likes to invest in. The giant oil company was recently priced at 73.40, giving it a dividend yield of 3.7 percent. The company raised its dividend by 12.1 percent this year, the 21st consecutive annual dividend increase. The supply of oil does not represent a problem for CVX. At the end of 2007, the company had proven reserves of approximately 10.8 billion oil-equivalent barrels.

    Johnson Controls (JCI) provides automotive interiors, products, and services that optimize energy usage in buildings and batteries for automobiles and hybrid electric vehicles. This makes JCI a large-cap green investment. The stock has been beaten down to a recent 14.65 based upon declines in housing and auto manufacturing. Analysts expect earnings per share growth of 25 percent next year, and an average growth rate of 15 percent over the next five years.

    Murphy Oil (MUR) is another worldwide oil and gas exploration and production company, with refining and marketing operations in the United States and the United Kingdom. MUR has a net operating margin of 20 percent, compared to an industry average of 5 percent. This well-managed company is likely to prosper as the economy recovers. Recent price: 46.26.

    National Oilwell Varco (NOV) is the fourth of five energy stocks to make our screen. Revenue for the most recent quarter reached $3.61 billion, and new orders totaling $2.4 billion during the quarter brought the total backlog to a record $11.8 billion, indicating a very profitable future for NOV. Sales growth has averaged 45 percent a year the past five years, nearly double the industry average. At a recent price of 25.35, NOV has a P/E ratio of 5.

    Safeway (SWY) operates nearly 1,800 grocery stores throughout the United States and Canada. SWY is the second largest grocery chain, and has a better than average net profit margin of 2 percent in a very challenging industry. Earning growth has averaged more than 10 percent a year, and the company is expected to maintain that steady rate of growth. SWY recently closed at 20.75.

    Sun Life Financial (SLF) is a Canadian insurer, facing the same difficulties as its U.S. counterparts. The company announced in October that it expected to maintain its dividend level, offering a 6.2 percent yield at the recent price of 19.22. For now, the dividend is covered by earnings, and the stock has performed in line with its peers over the past year.

    Total (TOT) is a $110 billion integrated oil and gas company with operations in more than 130 countries. At a recent price of 51.66, TOT yielded 5.5 percent, and has increased its dividend an average of 19 percent a year for the past five years. The company has a 32 percent return on equity, the second-highest in its industry.

    Weatherford International (WFT) is an $8 billion oil-field services provider which has grown earning by nearly 50 percent a year for the past five years. Analysts expect earnings to grow at 25 percent a year going forward, yet WFT has a P/E ratio of only 6 at the recent close of 12.47. The company has grown cash flow at an average rate of 176 percent a year over the last five years, and is now generating almost $1 billion a year in cash flow. This is the type of number that catches Buffett's eye.

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    Warren Buffett needs no introduction. Once again ranked by Forbes as the world's richest man, his stock-picking skills remain second to none.A study called "Imitation is the Sincerest Form of Flattery" shows that following in the footsteps of the investment legend can be...
    Wednesday, 19 November 2008 03:55 PM
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