What are we looking for?
Let’s get an update on a Canadian portfolio we created in April based on the investing style of Warren Buffett. We used a screen developed by Validea Canada that emulates the Oracle of Omaha’s methods.
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, 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.
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. 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.
Assuming an equal dollar investment in each stock, the portfolio is down 7.8 per cent from April 27 through Aug. 22, excluding dividends. That compares favourably with a drop of 13.1 per cent for the S&P/TSX composite index. Four months isn’t nearly long enough to gauge the effectiveness of any investment strategy, but the Buffett portfolio is off to a good start relative to the market.
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.