The Warren Buffett Stock Strategy: Berkshire Hathaway Inc. (BRK.B)

Valuing a Stock

Buffett uses several approaches, including:

Determining the firm’s initial rate of return and its value relative to government bonds: Earnings per share for the year divided by the long-term government bond interest rate. The resulting figure is the relative value—the price that would result in an initial return equal to the return paid on government bonds.

Projecting an annual compounding rate of return based on historical earnings per share increases: Current earnings per share figure and the average growth in earnings per share over the past 10 years are used to determine the earnings per share in year 10; this figure is then multiplied by the average high and low price-earnings ratios for the stock over the past 10 years to provide an estimated price range in year 10. If dividends are paid, an estimate of the amount of dividends paid over the 10-year period should also be added to the year 10 prices.

How Buffett Analyzes Financial Statements

Combine the methods from above with how Warren Buffett analyzes and interprets financial statements and you have a powerful “Buffett toolset”.

A Buffett Screen?

If you are itching to take it one step further, how about applying this Buffett screen I found in a Seeking Alpha article.

ROE: 5-year Avg. >= 17%

Return on Invested Capital: 5-year Avg. >= 17%

Pre-tax profit Margin: 5-year Avg. >= 1.2* Industry Avg. Pretax Margin: 5-year Avg.

Price/cash flow ratio <= 0.8* Industry Average price/cash flow ratio

Price/cash flow ratio >=0.1

Debt to Equity Ratio <= 0.8*Industry Average Debt to Equity Ratio

Income per employee >= 1.1* Industry Average Income per employee

Alas, There is No True Buffett Stock Criteria

Sorry for the anti-climax but until the day comes when Buffett publishes his methods, we will never know for sure what his secret sauce is.

There is a lot of debate over how he chooses stocks. This is a good start, but it is still only a start that covers the building blocks and basics.

Ultimately, it all comes down to practice and integrating the concepts that Buffett teaches into your own investing methodology. It’s always better to transform a lesson and make it your own.

Become your own guru.

This is probably Warren Buffett’s ultimate strategy as he sits somewhere smiling knowingly.

This article was originally written by Jae Jun, and posted on OldSchoolValue.