For Berkshire to continue increasing its operating earnings, its subsidiaries must achieve this since the parent company primarily serves as a capital asset allocator and has no real operations. Thus, Buffett’s economic goal is directly applicable to his investment selection criteria; he seeks steady growth in operating earnings.
To identify stocks that align with Buffett’s investment criteria, I screened for companies that have demonstrated a positive operating earnings compound annual growth rate (CAGR) and a negative shares outstanding CAGR over the past ten years.
I then calculated a combined value by subtracting the shares outstanding CAGR from the operating earnings CAGR. I ranked these values from highest to lowest and selected those with minimally 10% in combined value.
philosophy involves more than just two criteria. Over the years, Buffett has outlined several other factors he considers when evaluating investments. Therefore, there are at least four additional elements that could further refine this screening process.
First, given Berkshire's substantial size, investing in small-cap stocks isn't feasible. Additionally, a meaningful competitive advantage—or "moat"—often correlates with a certain scale; hence, stocks that are too small typically do not qualify. Therefore, I adjusted the filter to include only companies with a minimum market cap of $50 billion. Individual investors, however, may choose to relax this criterion.
Second, Buffett prioritizes investing in stocks with durable economic moats, which is a subjective measure. To align with this, I utilized Morningstar's wide moat ratings to identify stocks that are likely to maintain their competitive advantages over time.
Third, Buffett adheres to the principle of 'don't bet against America.' He has repeatedly expressed a preference for investing primarily within the U.S., leading me to exclude foreign stocks from my screening.
Fourth, it is crucial not to overpay, even for excellent businesses. Buffett insists that a wonderful company is not worth an infinite price. Valuation, however, remains a subjective area. I relied on Morningstar's valuation ratings, which range from 1 star (overvalued) to 5 stars (undervalued). For my purposes, I considered stocks with at least a 4-star rating to ensure they are not overpriced.
Before adding the fourth criterion regarding valuation, 31 stocks met the initial criteria. However, due to most of these stocks receiving less than 4 stars from Morningstar for valuation, only 4 stocks ultimately passed all criteria. This highlights that while there are many excellent businesses out there, most are currently trading at elevated prices. This is a key reason why Buffett is currently holding a record $189 billion in cash, with few attractive opportunities for deployment.
finally a backtest on these 31 stocks, which delivered an annual return of 21% over the past ten years, outperforming the S&P 500 ETF's annual return of 12%.
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