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Wednesday, September 19, 2012

FORBES: Warren Buffett Does Not Live On Value Alone

John Reese, Contributor

with Warren Buffett
with Warren Buffett (Photo credit: Wikipedia)

For years now, Warren Buffett‘s name has been nearly synonymous with the term “value investing.” A disciple of Benjamin Graham–the man known as the “Father of Value Investing”–Buffett has become the world’s most well-known investor thanks to his ability to ascertain the value of various securities and then buy them for less, a concept at the core of value investing. “Price,” he has said, “is what you pay. Value is what you get.”

But to label Buffett a “value investor” is probably an oversimplification. In reality, his strategy involves several different factors. In fact, in a recent paper, three members of AQR Capital Management found that value is not what has driven Buffett’s success over the past few decades. “The standard academic factors that capture the market, size, value and momentum premia cannot explain Buffett’s performance so it has to date been a mystery,” write Andrea Frazzini, David Kabiller, and Lasse H. Pedersen.

But in their study, they say, they “find that the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails.”

They estimate that Buffett applies about 1.6-to-1 leverage, financed in part by the Berkshire’s insurance float. They also find that Berkshire Hathaway‘s public holdings over the 1980-2011 period averaged a beta of 0.77, meaning that they tended to be a good deal less volatile than the broader market.

After studying Buffett for more than a decade, I wasn’t too surprised that high-quality, safer picks are responsible for his success. My Buffett-inspired Guru Strategy, which is based on the approach Buffett used to build his empire, puts just as much (if not more) emphasis on quality than it does on value metrics, and quality stocks tend to be less volatile.

The strategy looks for companies that have increased earnings per share in all or almost all years of the past decade; have enough annual earnings that they could, if need be, pay off all their debt within five years; and which have averaged returns on equity of at least 15% over the past 10 years–all signs of very high-quality businesses.

Whatever you want to call it–value investing, high-quality investing, low-beta investing high-quality-low-beta value investing–Buffett’s impeccable track record shows that his approach is well worth following.
Here’s a look at a handful of stocks that my Buffett-inspired strategy thinks are worth considering for your portfolio.




FactSet Research Systems (FDS): Connecticut-based FactSet provides global financial and economic data and analytical applications to a variety of customers in the financial world. The $4.6-billion-market-cap company has increased EPS in each year of the past decade, has no long-term debt, and has averaged a 26.5% return on equity over the past 10 years. The company’s shares trade at a 3.8% earnings yield, which, while not cheap, is still higher than the long-term Treasury yield, which pleases my Buffett-based model.

The Coca-Cola Company (KO): The Atlanta-based beverage giant ($172 billion market cap) is a longtime holding of Buffett’s Berkshire Hathaway, and also gets good scores from my Buffett model. A few reasons: Coca-Cola has upped EPS in all but two years of the past decade; it has enough annual earnings ($8.7 billion) that it could, if need be, pay off all its debt ($16.4 billion) in less than two years; and it has averaged a 30.0% return on equity over the past decade.

The stock also has a very low beta of just 0.52 over the past five years (betas cited here are from Zacks Investment Research). Its 5% earnings yield isn’t a bargain-basement price, but it’s a much higher yield than long-term Treasury bonds offer, and my Buffett model thinks it’s a good price for such a high-quality firm.
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C.H. Robinson Worldwide (CHRW): Robinson ($9.2 billion market cap) is a worldwide third-party logistics and freight company, meaning that it doesn’t own the transportation equipment it uses. It instead works with close to 50,000 transportation companies around the globe to provide truck, rail, air, and ocean freight services.
Varian Medical Systems (VAR): Palo Alto, Calif.-based Varian ($6.8 billion market cap) makes technologies that treat cancer and other conditions using radiotherapy, radiosurgery, proton therapy, and brachytherapy. It also makes X-Ray imaging tools used for a variety of fields, including medical and scientific arenas, cargo screening, and industrial inspections.

Varian has upped EPS in each year of the past decade, has just $6 million in debt vs. $411 million in annual earnings, and has averaged a 26.6% return on equity over the past 10 years, so it has the quality my Buffett model looks for. It also has a decent 5.9% earnings yield, and has a Buffett-like 0.87 beta.

Ross Stores (ROST): This California-based clothing apparel and home goods retailer, which operates under the Ross Dress for Less and dd’s DISCOUNTS names, is the nation’s second-largest off-price retailer. The $15-billion-market-cap firm has upped EPS in all but one year of the past decade, has nearly five times as much annual earnings as long-term debt, and has averaged a return on equity of more than 30% over the past ten years, all of which earn it high marks from my Buffett-based model.

Like Coke and Robinson, its valuation isn’t spectacular–its shares trade at a 4.8% earnings yield–but it’s still far above the long-term Treasury yield and offers excellent quality. The stock also has a beta below 0.7.

I’m long CHRW and ROST.

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