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Warren Buffett’s investment philosophy has drawn praise and admiration from investors for decades. The CEO and Chairman of Berkshire Hathaway (BRK.A) – Get Berkshire Hathaway Inc. Report focuses on value investing.
In essence, Buffett seeks to invest in stocks that sport prices cheaper than their intrinsic value.
Through smart, value-driven decisions, Buffett has grown Berkshire Hathaway to a market cap of $610 billion.
If you’re putting together a Buffett-inspired value portfolio, we’ve got five picks to consider.
The Buffettology Strategy
The bestselling book Buffettology, written by Mary Buffett and David Clark, outlines Buffett’s capital investment strategy. There are a handful of key parameters which help Buffett – or indeed, any good value investor – identify companies that may be priced below their intrinsic value.
Using the Stock Rover platform, we screened stocks based on some of the most important of those parameters. Specifically, we looked for companies that:
- Have a 10-year track record of increasing earnings-per-share (EPS) with no negative earnings years
- Do not have long-term debt greater than 5x their annual earnings
- Boast an average return on equity (ROE) over the past ten years of at least 15% and an average return on invested capital (ROIC) of at least 12% over the past ten years
- Have an earnings yield higher than a long-term Treasury yield (roughly 3.5%)
Below, we rank our top five picks based on these screening criteria. Companies are listed from highest to lowest earnings yields.
Checking all the boxes on the Buffettology checklist, Pfizer (PFE) – Get Pfizer Inc. Report is our #1 pick.
The American pharmaceutical giant has a 10-year track record of steadily-increasing EPS, and its long-term debt is well below 5x its current earnings.
Pfizer’s current robust ROE of 33.6% is above the pharmaceutical industry average of 30.9%. And, over the last ten years, Pfizer’s ROE maintained a solid 20% average.
With an impressive current ROIC of 24%, Pfizer generates healthy cash flow relative to its capital investment. For comparison, the average ROIC of the pharmaceutical industry is 18%.
Pfizer’s current earnings yield is 11%. Generally, investors consider companies to be attractively valued if they sport yields of 7% or greater. Of course, current yield is just one of many factors to be considered when trying to pin down future growth potential and overall valuation.
Shares of Pfizer are down 18% in 2022 year-to-date, roughly in line with the S&P 500. We think the company deserves better than falling in lockstep with the index, however. Based on the fundamentals, Pfizer is well ahead of most of its peers.
2. Cisco Systems
In second place is one of the largest software companies in the world, Cisco Systems (CSCO) – Get Cisco Systems Inc. Report.
CSCO’s EPS has shown respectable growth over the last decade. And, over those same ten years, Cisco has achieved an average ROE of 17% and an average ROIC of 13%. Those numbers put the company solidly in the “outperform” camp within the software industry.
The company’s long-term debt to assets ratio of 0.1 is also solid.
Cisco’s earnings yield of 6.4% also puts the company at a favorable valuation compared to its industry peers, especially when you factor in the company’s other robust profitability fundamentals.
YTD, though, Cisco shares are down a whopping 31% (slightly outstripping the losses of the tech-heavy NASDAQ). We think this company has been unfairly punished and is sitting at a very attractive price right now.
3. Taiwan Semiconductor Manufacturing Company
In third place, TSMC – Taiwan Semiconductor Manufacturing Company (TSM) – Get Taiwan Semiconductor Manufacturing Company Ltd. Report – is another technology giant that meets the requirements of Buffett’s strategy to a T.
The company has posted growing EPS for the past ten years. It has a ten-year average ROE of 21% and a ten-year average ROIC of 20%. Taiwan Semiconductor also boasts low debt numbers. TSM debt to assets stands around 0.2.
Each of these key values and ratios puts TSM well ahead of semiconductor industry averages.
Taiwan Semiconductor’s earning yield of 6%, while not exceptional, is nevertheless attractive compared to other big semiconductor names.
And TSMC shares’ losses have outpaced the NASDAQ’s losses YTD – the stock is down 40% in 2022. We see an excellent “buy the dip” opportunity here.
4. Home Depot
In fourth place is the home improvement retailer Home Depot (HD) – Get Home Depot Inc. (The) Report.
Not only has the company’s EPS risen over the past ten years, but it has risen substantially. Home Depot’s EPS has moved from $2.84 ten years ago to $16.35 today.
HD boasts an average ten-year ROE of 280 and an average ten-year ROIC of 30 – both numbers put it well above the retail industry average of -871.1% and 34.5%, respectively.
Home Depot does have significant amounts of long-term debt, which is a reason for some caution. However, the company’s net debt to EBITDA ratio sits at 1.4. Ratios of 3 and under are considered acceptable, so we’re not overly concerned about debt load here.
Nor has Home Depot’s long-term debt once exceeded 5 times its annual earnings in the last decade. That means the company aligns with our Buffettology debt criteria.
With an earnings yield of 6%, Home Depot’s yield is roughly in line with the industry average. But the company’s impressive ten-year growth and its solid balance sheet lead us to believe its precipitous 2022 drop – it has fallen 33% YTD – is undeserved.
Last but not least is Netflix (NFLX) – Get Netflix Inc. Report. Netflix shares have had an incredibly tough year, but the streaming giant nevertheless meets the Buffettology requirements. NFLX has presented robust fundamentals, especially over the past several years.
Over the last decade, Netflix has been progressively improving its EPS, with 2018 being a particularly positive inflection point.
The company boasts an ROE of 26.7% vs. the entertainment industry average of 6.1% and an ROIC of 17.5% vs. 9%. We’re certainly impressed by the streaming giant’s high profitability compared to its peer group.
Last year, the company managed to, for the first time, long-term debt levels below 5x its earnings, and we expect that trend should repeat itself this year.
Netflix’s sharp share price decline this year – the streaming giant is down 60% YTD – has made the company’s valuation much more appealing. Its current earnings yield of 4.8% also shows tremendous improvement from its more recent average yield of 1%.
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)