...and Buffett Style Buys

03/24/2006 12:00 am EST

Focus:

"Warren Buffett is widely regarded as one of the great value investors," notes S&P's David Braverman , who for ten years, has run a very successful annual screen to identify "stocks that Buffett might look into." Here, he looks at two that fit the bill.

"While Standard & Poor’s has a hold recommendation for Berkshire Hathaway, our analysts recommend purchase of many of the holdings in Buffett’s portfolio, including Coca-Cola (KO NYSE) and Procter & Gamble (PG NYSE). Buffett is closely identified with value investing, which he defines, in part, as buying equities that are ‘available at a sensible price.’ Buffett uses six investment criteria to look for opportunities in the market:

  • Free cash flow (net income after taxes, plus depreciation and amortization, less capital expenditures) of at least $50 million. (We raised the minimum amount in our screen significantly this year; it was $20 million previously.)
  • Net profit margin of 15% or more.
  • Return on equity of at least 15% for each of the past three years and the most recent quarter.
  • A dollar’s worth of retained earnings creating at least a dollar’s worth of shareholder value over the past five years.
  • Elimination of overvalued stocks. Overpriced stocks are identified by comparing our discounted cash flow estimate five years from now with the current price.
  • Ample liquidity. Only stocks with a market capitalization of at least $500 million are included.

"Our screen produced 40 names this year. It is important to note that these are not stocks that Buffett has purchased or has announced plans to purchase. They are merely stocks that meet criteria that Buffett has emphasized in the past. From February 13, 1995, through January 31, 2006, stocks identified by the screen posted annualized capital appreciation of 15.9% vs. 9.3% for the S&P 500. Two of the stocks, which are ranked four STARS for expected outperformance over the next 12 months, are appraised here.

"Equitable Resources (EQT NYSE), a Pittsburgh-based company that is engaged in natural gas production, transmission, and distribution, and also provides energy management services. We think Equitable’s exploration and production segment will continue doing well in 2006, from higher hedged prices and an aggressive drilling program. The company expects to drill 550 wells in 2006, mostly in its Appalachian holdings. However, we expect higher operating costs, reflecting a competitive market for drilling rigs and employment, to somewhat restrict profit growth.

"As we see it, Equitable has a solid growth outlook over the next three years and a relatively healthy balance sheet that is less leveraged than those of peers. We estimate earnings of $2.04 a share in 2006, including projected stock option expense. Our 12-month target of $43 is based on a P/E of 21 times our 2006 earnings estimate, at the upper end of peer valuations. We recommend the shares, which yield 2.4% from the $0.84 annual dividend, for potentially above-average total return.

"FactSet Research Systems (FDS NYSE) provides online integrated database services to financial firms, and we think this market is difficult for potential competitors to enter. As we see it, FactSet will benefit from improving conditions for its clients, particularly in light of the pickup in merger & acquisition activity and improved market returns in recent months. In addition, we believe the company’s strong cash flow and lack of long-term debt give it the financial flexibility to invest in future growth initiatives and to gain market share.

"We expect net subscription revenues to advance 20% in fiscal 2006 (ending August), reflecting a nearly 28% rise in fiscal 2005 subscription bookings and expected contributions from two recent acquisitions. In our view, revenues will increase another 12% in fiscal 2007. Excluding tax benefits and gains, we see net operating earnings of $1.47 in fiscal 2006 vs. the $1.26 posted in fiscal 2005. We forecast another rise in operating earnings to $1.71 in fiscal 2007. We have a 12-month target of $48, derived from our discounted cash flow analysis, and we recommend purchase."

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