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:
|
Company |
Business |
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.
