Text size

When Warren Buffett, the third wealthiest person in the world, acquires a stake in a company, investors pay close attention, especially as shares often rise when such news is disclosed.

A recent screen searched for stocks that could appeal to Buffett turned up Sysco (SYY), the food distributor; Cummins (CMI), a maker of heavy-duty engines; and Illinois Tool Works (ITW), a roll-up of industrial equipment manufacturers.

Investors don't have to guess which stocks Warren Buffett likes, of course. His investment company, Berkshire Hathaway ( BRKA ) ( BRKB ), must report its positions each quarter, and from these "13-f" filings investors can deduce recent buys and sells.

A Feb. 14 filing shows that Berkshire last quarter took new stakes in crop processor Archer Daniels Midland (ADM) and VeriSign (VRSN), which provides Internet services like domain name registry. It trimmed exposure to Johnson & Johnson (JNJ) and cut Kraft (KFT). It added to stalwarts like IBM (IBM), General Motors (GM), Wal-Mart (WMT) and Wells Fargo (WFC).

Berkshire also added to holdings of smaller companies: DirectTV (DTV), drilling equipment maker National Oilwell Varco (NOV); Wabco Holdings (WAB), which sells train brakes; DaVita Healthcare Partners (DVA), which provides kidney dialysis; and Precision Castparts (PCP), which makes high-end casts that give shape to things like airplane engine blades and artificial knees.

Plenty of these stocks can still be had cheaply. Archer Daniels, for example, sells for 13 times this year's earnings forecast, versus 14 times for the broad U.S. stock market.

Investors seeking to beat Buffett to his next pick, however, may take interest in recent research from Thomson Reuters analyst John Kozey. He screened the market for companies with a handful of attributes Buffett is known to favor. Among them are modest debt, attractive valuations and growing (but not necessarily fast-growing) revenues and profits.

To judge valuation, Kozey used a measure called EV/Ebitda. Enterprise value, on the top side of the ratio, adjusts a company's stock value for its debt and cash. Earnings before interest, taxes, depreciation and amortization, on the bottom side of the ratio, is a measure of profits that ignores some non-cash charges that stem from past investments rather than current operations. Merger-and-acquisition analysts sometimes use EV/Ebitda to judge whether companies are priced right for takeovers.

Kozey's screen turned up 28 names in total. Only one, Archer Daniels, is a current Berkshire Holding, which illustrates how no screen can precisely match the tastes of Buffett himself. The list of screen survivors is a good place to start a search for stock bargains, however.

Sysco is the largest food distributor in North America, with an 18% share of the market. Its size gives it better profit margins than peers and a sales network that's difficult for competitors to match. It also makes Sysco a natural buyer for smaller distributors; it bought four in December. A jump in food prices last year cut into the company's profits, but prices have cooled off of late. Wall Street expects the company's revenues to increase 6% this year and next. Shares come with a 3.4% dividend yield.

This column recommended Cummins (CMI) shares back in October (see "Cummins Can Come Back"). They're up 35% since then, but still look affordable at 13 times earnings.

Cummins makes engines for trucks and generators, building the most lucrative components in-house and outsourcing the rest to others. It stands to benefit long-term from rising construction in emerging markets, which will spur truck purchases, and tighter emissions controls the world over, which will drive many truck owners to replace their fleets. Cummins comes with a 1.8% dividend yield, and its payment looks in need of a boost, making up less than one-quarter of profits.

Illinois Tool Works has a long history of making tiny takeovers of manufacturing companies and giving each local control over operations. That has resulted in more than 800 decentralized divisions, and not enough cost-savings to please major shareholders. The company announced in December that it would reduce its number of divisions to 150; consolidate managers, factories and raw-materials buying; shed slow-growing or low-margin businesses; and look for fewer small acquisitions (but perhaps some larger ones). All of this could result in a gradual rise in profit margins in coming years and turn a pretty good stock (it has doubled in price over the past decade and carries a 2.5% dividend yield) into a better one.

Here's the full list of screen survivors:

Mosaic (MOS)

Newmont Mining (NEM)

PPG Industries (PPG)

Air Products & Chemicals (APD)

Nucor (NUE)

Eastman Chemical (EMN)

Johnson Controls (JCI)

General Mills (GIS)

Archer Daniels Midland (ADM)

Sysco (SYY)

Hershey (HSY)

Campbell Soup (CPB)

Coca-Cola Enterprises (CCE)

Baker Hughes (BHI)

Transocean (RIG)

Illinois Tool Works (ITW)

CSX (CSX)

Norfolk Southern (NSC)

Cummins (CMI)

Paccar (PCAR)

Ingersoll Rand (IR)

Tyco International (TYC)

Parker Hannifin (PH)

Stanley Black & Decker (SWK)

Dover (DOV)

Rockwell Automation (ROK)

Republic Services (RSG)

Fluor (FLR)

Comments? E-mail us at editors@barrons.com