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09/01/2015 9:00 am EST
It is tough for Warren Buffett to find companies that can really move the needle for his stock portfolio of over $100 billion, explains Marshall Hargrave in Investors Alley.
As retail investors, however, we can use Buffett’s methodology to find smaller companies that Buffett and large asset managers just can’t invest in.
In Buffett’s recent shareholder letter, he lays out his criteria for companies he looks to buy. First, companies should have current earnings power and not be turnaround situations.
The big metric Buffett looks for is return on equity. But not just a high ROE, the company has to have a history of generating a high ROE for many years.
All three companies below have median 10-year ROEs of 17% or higher.
While Buffett likes companies that can generate nice returns on shareholder capital, he’s not a fan of using too much debt to do so.
Thus, look for companies with low debt-to-equity ratios; all three stocks below have debt-to-equity ratios of below 50%.
Finally, Buffett is notorious for sticking to companies that are easily understood. With that in mind, here are three stocks that Buffett would buy if he could:
Lear makes the list and is the $8 billion supplier of auto seats and electric power systems, This sticks to Buffett’s industrial theme nicely and its current ROE is nearly 25% and its 10-year median ROE is 19%.
Granted, Lear went through bankruptcy reorganization a number of years back, but since then it’s been an earnings generating machine. It has a debt-to-equity ratio that’s just around 20% and is using cash to buy back stock.
Lear is a great play on the growing global premium-vehicle segment as well as electric and electric hybrid vehicles, which contain higher power-management content.
Thor Industries (THO)
Thor is the world’s largest maker of recreational vehicles, a sizable moat, which Buffett likes. Thor has over 1,300 dealers across the US and Canada.
Thor checks another major box for Buffett, a lengthy history of earnings. Thor has been profitable for every year since inception in 1980. Its ROE is over 17% and it has virtually no debt, with a debt-to-equity ratio of 8%.
Buffett loves industrials. Along those lines, Fluor is the leader in engineering and construction, with a $7 billion market cap.
Its ROE is over 17% and its debt-to-equity ratio is a mere 13%. The beauty of Fluor is that it also checks another key box for Buffett, strong management.
Fluor is a play on the global rise of a company’s desire to manage costs. It also has a backlog of over $40 billion worth of work. A key tailwind for Fluor includes the urbanizing of emerging markets.
Chicago Bridge & Iron (CBI)
As a bonus, if you dig through Buffett’s current portfolio, you can still find some small-cap gems, including Chicago Bridge & Iron, which you can buy cheaper than Buffett paid.
Buffett has a $527 million position in this $5.5 billion market cap engineering and construction company.
The stock has taken a beating despite strong operational performance and a strong backlog of projects.
In the end, following Buffett’s actual stock picks isn’t a horrible investing strategy. But, actually, using his methodology to find undiscovered stocks looks to be much more worthwhile.
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