What are we looking for?
Canadian stocks that Warren Buffett would love.
Unfortunately, Mr. Buffett wasn't available for our little stock-picking exercise. But the folks at Validea Canada have developed a screen that emulates the Oracle of Omaha's methods - without all the corny jokes and grandfatherly advice.
The Buffett methodology
Considered by many to be the world's greatest investor, Mr. Buffett aims to buy solid businesses at good prices and often holds them for decades. He summed up his investing philosophy in his 1996 letter to Berkshire Hathaway shareholders this way:
"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10 and 20 years from now.
"Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."
More on Buffett's style
Mr. Buffett doesn't try to capitalize on day-to-day price fluctuations, but instead focuses on the company's business. He looks for companies with strong, long-term track records, and tries to buy them at a "fair" price.
"We prefer a great company at a fair price, rather than a fair company at a great price," he once said.
Time is another key ingredient in his formula.
"He knows that, over time, the stocks of firms with strong businesses and good long-term prospects are likely to rise considerably, regardless of what those stocks are doing today or tomorrow or next week," Validea says.
In developing its "Patient Investor" screen, Validea relied on the book Buffettology, written by Mr. Buffett's former daughter-in-law, Mary Buffett. The screen "is the only one of our strategies that is not taken directly from the writings of the guru himself, as Buffett has yet to write about his investment strategies" in detail, Validea says. (Globe Investor has a joint venture with Validea.ca.)
The 10 stocks in the table are those that scored highest, as of April 27, based on the book's interpretation of Mr. Buffett's strategy. You'll notice that all but one of the price-to-earnings ratios are less than 20, which is consistent with Mr. Buffett's desire not to overpay for a stock. (Mr. Buffett is also known to be a fan of the earnings yield, which is simply the reciprocal of the price-to-earnings ratio. The higher the earnings yield, the more profit the company is making relative to its share price.)
Also, all but one of the stocks has demonstrated earnings growth over the past five years. (Validea's "long-term EPS growth" number is actually an average of the three-, four- and five-year annualized growth rates, to smooth out the effects of one exceptionally good or bad year.)
The PEG ratio is the P/E divided by the long-term earnings growth rate. Generally, the lower the PEG, the more attractive a stock is from a valuation standpoint.
As always, don't buy stocks based solely on the results of a single screen. Use the information as the starting point for further research.