A stock that follows Buffett's roadmap to profits
Posted
Jul 29 2009, 08:56 AM
by
John Reese
Rating:
There are very few stocks that obtain 100% score based on the Warren Buffett investment model I run on Validea.com.
The strategy (outlined by Buffett's former daughter-in-law Mary in her book Buffettology) is one of the more rigorous approaches I’ve developed over the years. It combines earnings predictability measures along with balance sheet, cash flow, and expected return estimates to determine whether or not a stock gets a passing grade, and on some criteria digs back ten years into a stock's fundamentals.
The method is so rigorous that, right now, only eight of the more than 6,500 stocks that I continuously analyze on Validea.com get a top ranking of 100%. (Click here for details on Validea’s Premium Buffett screen). One of them in particular recently caught my eye -- and since I added it to my public MSN Money TopStocks Wall Street Survivor portfolio on June 15, 2009, the stock is up about 25%.
Interestingly enough, this company’s a technology firm (something that Buffett has publicly said he shies away from due to the complexities of the business and the changing competitive landscape). Given how integral a part of life technology has become, however, I let my Buffett-based algorithm roam free in search of the best ideas -- and one of those top ideas right now is Garmin (GRMN), the maker of GPS navigation, communication, and information devices and applications.
Validea’s Buffett model, which is up nearly 32% so far this year, is a 100% systematic based approach that looks only at the facts and figures -- no hunches, no guesswork. While Garmin may not sound like a company Buffett's Berkshire Hathaway would own, I think it’s worth a look, as it exhibits quite a few fundamental qualities that Buffett looked for in stocks while building his empire. A quick summary of Validea's Buffett model's analysis of Garmin:
• Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Garmin has upped earnings per share in eight of the past 10 years, increasing EPS from $0.32 to $3.48 in that time.
• Buffett likes companies that are conservatively financed. GRMN has no long-term debt, which my Buffett model loves.
• Buffett likes companies with above-average return on equity of at least 15%, as this is an indicator that the company has the "durable competitive advantage" he so often talks about. The average ROE for GRMN over the last 10years is 28.5%, nearly doubling my Buffett-based model's 15% minimum. It's been even higher of late, averaging 33.3% over the past three years.
• Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. The average ROTC for GRMN, over the last ten years, is 27.5% and the average ROTC over the past 3 years is 33.3%, which is high enough to pass.
• Buffett likes companies that do not have major capital expenditures. GRMN's free cash flow per share of $2.81 is positive, indicating that the company is generating more cash that it is consuming, a good sign.
• Buffett likes to see that management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years ($12.01 in the case of GRMN) and compares it to the gain in EPS over the same period of ($3.16 for Garmin). Based on those figures, GRMN's management has proven it can earn shareholders a 26.3% return on the earnings they kept -- more than double the 12% minimum this model looks for.
• My Buffett-based model uses two ways to calculate an expected future return for stocks, one based on return on equity, and the other based on EPS. The ROE method starts with a stock's book value and then uses a few other factors -- the percentage of earnings the firm has historically retained, the return on equity it has produced on those earnings, its five-year or current price/earnings ratio (whichever is lower) -- to determine a future stock price. Based on all of that, my Buffett-based model expects GRMN to return an average of 24.2% per year over the next decade.
The EPS method, meanwhile, uses current EPS, consensus long-term growth estimates, and the lower of the five-year or current P/E ratio to estimate what a stock's price will be ten years out. Using this method, the Buffett-based approach projects a 14.2% annual return for GRMN over the next ten years. Average that with the ROE method's 24.2% figure, and you get an average expected rate of return of 19.2% per year over the next ten years. That easily surpasses this model's 15% target. (The full ROE and EPS methodologies are detailed in my new book, The Guru Investor: How to Beat the Market Using History's Best Investment Strategies.)
Garmin may not be the type of stock that Buffett would consider for Berkshire today, but it has the kind of fundamentals and balance sheet that Buffett looked for in stocks he bought while building his empire and reputation. And that makes it the type of stock any investor should give a closer look.
Meanwhile, take a look at the other stocks in my Top Stocks tracking portfolio at Wall Street Survivor.
Full disclosure: I own GRMN.
John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book, "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".
