Warren Buffett has proven over the last 50 years to be the most successful investor of all time. With an average compound rate of return of 23.3% per year, he and his good friend Charlie Munger have a reputation that Wall Street can only dream of. His wise investing has grown his company Berkshire Hathaway (BRK.A) into a behemoth worth over $500 billion.
But how did Buffett achieve these great investing returns? He analyses stocks better than anyone else and understands what makes a great company.
The Warren Buffett Stock Screener
A Warren Buffett Stock Screener needs to filter on investing criteria such as earnings per share (EPS) growth, consistent return on equity (ROE), high return on invested capital (ROIC) and low debt using the solvency ratio. Finally, the screener needs to calculate the margin of safety using discounted cash flow (DCF).
How Does Buffett Screen for Stocks?
Buffett screens for stocks using specific criteria is the company profitable and generating a healthy cash flow. He then predicts and discounts the cashflow 10 years into the future. If the value of the cash flow is 30% higher than the stock market valuation of the company, then it has a good margin of safety and it is a candidate for purchase.
How To Build A Buffett Stock Screener
- Understand What Warren Buffett Looks For In Stocks
- Implement Those Metrics Into A Stock Screener
- Understand How Buffett Evaluates The Business & Industry
- Select The Stocks From Your Screener & Invest In Them
Section 1 is very detailed if you do not want to read about all the criteria and methodology, jump directly to Section 2 – Implementing the Stock Screener
1. Understand What Warren Buffett Look For In Stocks
In this first step, we take a look at the key financial metrics to screen the stocks against. The most detailed analysis of Buffett’s investing methodology is outlined in the book “The New Buffettology” by his daughter Mary Buffett. We will use the Buffettology book, plus the two single most important criteria created by his mentor the great Benjamin Graham, Fair Value (Intrinsic Value) and Margin of Safety.
Look for Fair Value Higher Than The Current Stock Price
Warren Buffett bases his Intrinsic Value / Fair Value calculations on future free cash flows. To explain, Buffett thinks cash is a company’s most important asset, so he tries to project how much future cash a business will generate and also discount it against inflation. This is called the Discounted Cashflow Method. Read more about Buffett’s Fair Value Calculation.
Screener Calculation – Fair Value 30% Higher Than Share Price
A High Margin Of Safety
Probably Buffett’s most important measure to decide whether to invest in a company.
Warren Buffet describes Margin of Safety like this
If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger the margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay; but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety…
The Margin of Safety is the percentage difference between a company’s Fair Value and its actual stock price. This metric is the single most significant valuation metric in our arsenal as it is the final output of detailed discounted cash flow analysis.
Screener Calculation – Margin of Safety > 20% (Only available in Stock Rover)
It will come as no surprise that earnings per share (EPS) is a very important metric for Buffett and Wall Street. Buffett looks for companies with a consistent track record of earnings growth, particularly over a 5 to 10 year period.
Screener Calculation – Yearly EPS growth Year on Year
A Consistently High Return on Equity
This is a profitability measure calculated as net income as a percentage of shareholders’ equity, also called ROE. A high ROE shows an effective use of investor’s money to grow the value of the business.
Screener Calculation – Return on Equity (ROE) 0> 15%
Does the Company Earn a High Return on Total Capital?
Return on Invested Capital (ROIC), quantifies how well a company generates cash flow relative to the capital it has invested in its business.
It is defined as Net Operating Profit after Taxes / (Total Equity + Long-term Debt and Capital Lease Obligation + Short-term Debt and Capital Lease Obligation)
Screener Calculation – 10 Year ROIC Average => 12%
Is the Company Conservatively Financed?
“For a company to pull out of any business difficulties it may encounter, it needs plenty of financial power. Companies with a durable competitive advantage usually create such great wealth for their owners that they are long-term-debt-free or close to it. Standard debt-to-equity ratios give a poor picture of the business’s financial strength in that shareholder’s equity is seldom used to extinguish the debt. The earning power of a business is the only real measure of a company’s ability to service and retire its debt. You need to ask yourself, how many years of current net earnings would be required to pay off all the long-term debt of the business in the current year?”. Source The New Buffettology
To achieve this very specific calculation you can use the closest match, the Solvency Ratio.
The solvency ratio is a measure of whether a company generates enough cash to stay solvent. It is calculated by summing net income and depreciation and dividing by current liabilities and long term debt. A value above 20% is considered good.
Screener Calculation – Solvency Ratio > 20%
The Initial Rate of Return for the Stock is Greater than The Return on U.S. treasury bonds?
If a company cannot make a profit per share higher than the return of a safe asset like treasury bonds, then you should not invest in it. This is an easy calculation and we will use the Earnings Yield. Earnings Yield is the earnings per share for the most recent 12-month period divided by the current market price per share.
Screener Calculation -Earnings Yield > 3%
2. Implement Those Metrics Into A Stock Screener
To my knowledge, there is only one Stock Screener and Stock Analysis platform on the market that will enable you to implement a real Buffett Stock Screener.
The best tool for the job is the Winner of our Top 10 Best Stock Screeners Comparison – Stock Rover. Also, Stock Rover won our Best Value Investing Stock Screener
5 Easy Steps To Setup Your Warren Buffett Stock Scanner in Stock Rover.
Step 1 – Get Stock Rover
Sign Up For A Free 14 Day Trial of Stock Rover (no card required), this will give you the Premium Plus Service for free for 14 days. You need the Premium Plus Service to access the awesome Fair Value and Margin of Safety criteria, exclusive to Stock Rover.
Step 2 – Locate The Buffettology Screener
Once you have registered and logged in to Stock Rover, locate Screeners from the navigation menu, hover over it with your mouse and select the drop-down arrow then select Browse Screener Library.
Screeners -> Browse Screener Library
This will take you to a huge selection of expertly curated Stock Screener templates.
Step 3 – Import The Buffettology Screener
Scroll down to the Buffettology Inspired screener, select the checkbox to the right, and finally click the Import Item Selected Button.
Locate Buffettology Inspired -> Click Checkbox -> Import Items
Step 4 – Setup Your Buffett Specific Columns View
Now your screening criteria is already setup, but you need to be able to see the right columns that are directly relevant to the methodology outlined in section 1 of this article.
Click on Actions at the top of the application and select Update View
Actions -> Update View
Step 5 – Configure The Columns For Your Buffett Stock Screener
The screenshot above shows you exactly which columns to select. Remove any unneeded columns. Finally, click Save.
Complete – You Now Have The Perfect Warren Buffett Stock Screener
This single view gives you the ability to see at a glance all the stocks that meet the Warren Buffett test but also do your own further investigation.
I have sorted this view on Margin of Safety so I can see the safest stock first.
Now you are ready to perform some final checks, to do this you need to understand how Warren thinks about business.
|Get A Free 14 Day Stock Rover Trial||Read The Stock Rover Review||10 Best Stock Screeners Comparison|
3. Understand How Buffett Evaluates The Business & Industry
There are certain factors that Buffett considered that are not found in the balance sheet or financials. They are business and competition-related questions, that need a further deep dive. Now that you have your potential targets stocks in your screener windows above. Select a stock you like the look of, and ask the following Buffett questions as outlines in the Buffettology book.
Does the company have an identifiable durable competitive advantage?
The competitive advantage over others in the industry might be better technology, better products, patents, or even a captive market. Does the company’s industry, for example, have high barriers to entry, e.g. a microchip maker, or telecoms company? Also, do not forget, is a competitive advantage durable, meaning, will it last for at least 10 years.
Do you understand how the product works?
Buffett always says that if he does not understand how the product or service works, then he will not invest. The idea is, that is you cannot understand the business, you will not be able to accurately assess potential threats or competition. He wants to only invest money in companies he can understand.
If the company does have a durable competitive advantage and you understand how it works, then what is the chance that it will become obsolete in the next twenty years?
Does the company allocate capital exclusively in the realm of its expertise?
Is the company free to raise prices with inflation?
If the company has severe competition which is pushing product or service prices downward, then this may be a stock to avoid. At least if prices are not able to increase with inflation then you may need to factor this into the valuation and Margin of Safety.
Are large capital expenditures required to update plant and equipment?
This question is aimed at companies that have to invest heavily in plant and equipment to remain competitive, for example, carmakers or telecoms companies. These infrastructure upgrades can take a huge toll on debt and free cash flow.
Is the company’s stock price suffering from a market panic, a business recession, or an individual calamity that is curable?
This is the magic question and the question that leads to Buffett’s famous quote.
Bear fearful when others are greedy, and be greedy when others are fearful
If the market is going through panic, a stock with great company fundamentals (financials), low competition, and a solid competitive advantage could see it’s stock price fall dramatically. This would be a great time to buy, as you will see a higher Margin of Safety.
Is the company actively buying back its shares?
One sign Mr. Buffett looks for is companies buying back their own shares. This usually means that the company’s management sees a bright future and also believes the company is seriously undervalued by the stock market. This is often a good sign.
4. Select The Stocks From Your Screener & Invest In Them
Now you have narrowed down the stocks that you want to buy so that you can build your portfolio. Remember, Warren always says:
The best time to sell is never
Although not a strict rule, it pertains more to the fact that you need to buy and hold for the long-term. If you have done your job well, you will not need to sell for the foreseeable future.
Buffett Stock Screener Results – Top Companies
Here are the companies selected by the Stock Rover Screener, sorted on margin of safety
|Ticker||Company||Value Score||Price||Fair Value||Margin of Safety||EPS 5-Year Avg (%)||Annualized 10-Year Return||Earnings Yield||Return on Equity||ROIC||Solvency Ratio|
|TPL||Texas Pacific Land Trust||69||$658.97||$997.95||51%||57.6%||36.6%||5.9%||79.0%||119.3%||912%|
|WMMVY||Wal – Mart de Mexico SAB||84||$29.95||$39.97||33%||11.6%||7.8%||3.7%||25.4%||22.8%||32%|
|USNA||Usana Health Sciences||88||$71.99||$93.05||29%||12.0%||16.8%||6.2%||28.4%||25.3%||91%|
|TROW||T. Rowe Price Group||79||$118.12||$149.11||26%||13.0%||13.6%||6.7%||29.9%||30.8%||536%|
|UVE||Universal Insurance Hldgs||97||$28.75||$33.34||16%||12.5%||25.5%||10.7%||19.1%||18.0%||1016%|
|WSTG||Wayside Technology Group||96||$14.87||$13.60||-9%||0.4%||11.8%||9.5%||14.5%||14.8%||11%|
|WMMVF||Wal – Mart de Mexico SAB||84||$2.89||$2.34||-19%||11.6%||–||3.8%||25.4%||22.8%||32%|
Table: Date September 2019
- Further Reading: How to Build an Ethical ESG Portfolio
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