How To Screen for Stocks Using 12 Buffett Investing Fundamentals
When it comes to investing using the basic principles of fundamental analysis, Warren Buffet is considered the modern messiah. While some critics feel that Buffett’s strategy cannot be duplicated, author of a number of popular books that highlight Buffett’s core investment principles, Robert Hagstrom, CFA, disagrees. In The Essential Buffett: Timeless Principles for the New Economy, Hagstrom argues that it is possible to duplicate Buffett’s strategy through an initial four stage approach with any potential investment. They are:
- Analyze a stock as a business
- Demand a margin of safety for each purchase
- Manage a focused portfolio
- Protect yourself from the speculative and emotional forces of the market
Hagstrom identifies 12 basic Buffett principles that a company should possess to be considered for purchase. Not all of Buffett’s purchases displayed all these tenets, but as a group the principles help to establish a reasonable approach to selecting stocks. The tenets cover both qualitative and quantitative business elements. These are used to create the Buffett Hagstrom screen.
Buffett’s Business Tenets
1. Is the business simple and understandable?
2. Does the business have a consistent operating history?
3. Does the business have favorable long-term prospects?
4. Is management rational?
5. Is management candid with its shareholders?
6. Does management resist the institutional imperative?
7. Focus on return on equity, not earnings per share.
8. Calculate “owner earnings.”
9. Look for companies with consistent and high profit margins.
10. For every dollar retained, make sure the company has created at least one dollar of market value.
Valuing a Stock
11. What is the value of the business?
12. Purchase stock if it can be acquired at a significant discount to its valuation.
In summary, Warren Buffett’s approach identifies “excellent” businesses based on the prospects for the industry and the ability of management to exploit opportunities for the ultimate benefit of shareholders. He then waits for the share price to reach a level that would provide him with a desired long-term rate of return. Most investors have little trouble understanding Buffett’s philosophy but its successful implementation is dependent upon the dedication of the investor to learn and follow the principles. It requires the ability to stick to the approach during times of market volatility.