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What exactly is a "Buffett stock?" Unhelpfully, I could answer, "A stock that Warren Buffett might like."

Since Buffett is lauded as one of the best investors of the modern era, it makes sense that pretty much everyone wants to find stocks that Saint Warren of the Equities might approve of. But since it's easy to twist and readapt things that Buffett has said at one time or another, there are plenty of instances of stocks being hyped as "Buffett worthy" that, well, aren't even close.

My colleague Ilan Moscovitz and I have jumped on something we've dubbed the "Buffett ratio." The Buffett ratio is a measure of profitability similar to return on capital that he outlined in his most recent letter to Berkshire Hathaway (NYSE: BRK-B  ) shareholders.

Last month, Ilan rounded up the 10 companies that have the highest Buffett ratio. I thought that I'd pick it up from there and whittle down the list a bit further. So for our purposes, a "Buffett stock" is one that has a high Buffett ratio, a low valuation, and a business that is relatively predictable.

Notably, Lubrizol -- a company that Berkshire is acquiring -- shows up on this list. Here are five more that make the cut:



Buffett Ratio

Forward Price-to-Earnings Ratio

Autoliv (NYSE: ALV  ) Safety products for autos 34% 10.6
Telefonica (NYSE: TEF  ) Telecommunications 31% 9.6
Teva Pharmaceutical (Nasdaq: TEVA  ) Generic drug manufacturer 49% 9.8
Whirlpool (NYSE: WHR  ) Home appliances 32% 7.8
Newell Rubbermaid (NYSE: NWL  ) Branded home and office goods 81% 11.3

Source: Capital IQ, a Standard & Poor's company.

In choosing these companies, the two numbers were easy -- I just waved on any company that had a Buffett ratio above 25% (the point at which Buffett considers the company to have "terrific economics") and a forward P/E below 12.

The business part was a bit trickier. Since I wanted businesses that were relatively predictable, I asked myself: What is the chance that this company's business environment will be drastically different five years from now? Despite having a Buffett ratio of 100%, GT Solar (Nasdaq: SOLR  ) didn't make the cut -- it's simply too hard to guess where the solar industry will be years in the future.

Looking closer
It's a different story with the companies in the table above. Autoliv is a leader in auto safety products including airbags, seatbelts, steering wheels, and child seats. The auto slump that came with the recession showed that Autoliv's business isn't impervious to pain, but my bet is that five years hence, people will still be buying cars and those cars will all include safety systems.

Telefonica hasn't gotten much love from investors lately, and that may have a lot to do with the fact that it's based in Spain. However, more than 40% of the company's revenue comes from Latin America, and nearly 60% of the group's operating profits come from the same region. Telecommunication providers aren't especially exciting, but they're very essential, so Telefonica's business definitely makes the cut.

I don't have the quite the pessimistic outlook on big pharma that many investors seem to have. But you don't need to be bullish on a big pharma research renaissance to like Teva. The company has some proprietary drugs of its own, but nearly 70% of the company's sales come from generic products -- a business line that benefits from other pharma players' drugs coming off patent.

Like Autoliv, Whirlpool took some serious lumps during the recession. But when I think about 2016 and how we will be doing our laundry, storing our food, and washing our dishes, I see Whirlpool. And it doesn't hurt that the company is actively building its presence in high-growth countries like India and China.

Newell Rubbermaid wants customers to say "wow" when they use the company's products. Admittedly, I don't picture myself finding its products quite that exciting. I do, however, picture myself -- and many other consumers and businesses -- still making use of the company's branded products years into the future. And in case you're not familiar, Newell's brands include Rubbermaid, Graco, Calphalon, Sharpie, Paper Mate, and Lenox, among others.

And in case you need any more incentive to check these companies out, every single one of these companies also pays a dividend -- which is something always worth paying attention to.

Tune in
This is a starting point on the five stocks mentioned. I think all of them have buy-to-own potential, but now it's your turn to take the ball and run with it. To stay up to date on what's going on at these companies, click the "+" above to add them to your Foolish watchlist. Don't have a watchlist yet? Click here and start fresh.

Autoliv is a Motley Fool Hidden Gems choice. The Fool owns shares of Autoliv. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (9) | Recommend This Article (49)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2011, at 1:06 PM, JAVEROA wrote:

    So what exactly is the metric?

    Why don't you explain that first?

  • Report this Comment On April 20, 2011, at 3:50 PM, TMFKopp wrote:


    The metric is explained further in the links above:

    As noted in the article, it's a measure similar to return on capital, but it excludes intangible assets. Unfortunately, Buffett didn't walk us through the exact calculation, but the way I've been calculating it is:

    Taxed EBIT / (Tangible Book Value + Total Debt)


  • Report this Comment On April 20, 2011, at 5:21 PM, pastreet wrote:

    The other characteristic of Warren Buffett's that is vastly underestimated is his optimistic outlook. Although he is surely a numbers man, he has always been able to see the forest for the trees and avoid getting sucked into the pessimism of the day.

    "Be greedy when others are fearful, fearful when others are greedy."

    If that's not a plug for cautious optimism, I don't know what is.


  • Report this Comment On April 20, 2011, at 6:29 PM, TMFKopp wrote:


    Of course you have to figure out when everyone else is greedy and when everyone else is fearful -- which is often no easy task.


  • Report this Comment On April 20, 2011, at 7:39 PM, jeffgreen123 wrote:

    Thanks for this series of articles, Matt. I have been attempting to replicate your numbers, but I haven't been able to get them quite right. Can you show a sample calc and where you got your numbers from? That would be very much appreciated.



  • Report this Comment On April 20, 2011, at 10:08 PM, cordwood wrote:

    NWL and MMM are two companies that I admire as producers of innovative usefull products. BUT, both give me a numb feeling re their stocks....and have done so over many years.

    Difficult to ascertain just what Buffet would see in NWL that would overcome my numb opinion of it,or MMM.

    Any hoooo,thanks ,Mat, for the article/list always good to jog the cranium w/ someone elses "date book".

  • Report this Comment On April 21, 2011, at 2:34 AM, TMFKopp wrote:


    Sure thing Jeff. Let's use ALV as our guinea pig.

    I'm grabbing my numbers from Capital IQ rather than directly from the filings, so hopefully they line up pretty well.

    LTM EBIT: $950 mil

    LTM tax rate: 25%

    Taxed EBIT = $713 mil

    3/31 Tangible Book: $1,373 mil

    3/31 Total Debt: $747 mil

    TBV + Debt = $2,120 mil

    Buffett Ratio = $713 mil / $2,120 mil = 34%

    Let me know if any of this doesn't make sense...


  • Report this Comment On April 21, 2011, at 12:54 PM, jeffgreen123 wrote:

    Thanks Matt -

    The major thing it appears that I was missing is that you used the last twelve months, and I was going off of the annual report. The numbers I was getting were close, but slightly off and that is probably why.

    Thanks for taking the time to step through the calc for me. It is much clearer now.



  • Report this Comment On April 21, 2011, at 2:15 PM, TMFKopp wrote:


    No problem, glad I could help clear that up!


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