For this particular screen, we start with approximately 150 stocks identified to have a durable competitive advantage that are also in solid financial health. Highly levered companies and companies with inefficient inventory and cash conversion metrics have been excluded.
The stocks were subsequently filtered by:
• 5-Year ROE and TTM greater than 15%
• 3-Yr EPS, revenue, and book value growth at least stable (i.e. they did not decline over the period)
• We chose the top 10 companies (based upon average ROE), and then sorted according to 5-Year ROE
• Forward and TTM PE less than 15
Here is the output:
What we have for an output is 10 wide-moat companies with a five-year average ROE in the range of 21%-44%, indicative of a durable competitive advantage. Note that Microsoft (MSFT) has produced the highest fove-year ROE on this list. We can also note the three-year growth of revenues, EPS and book value to get an understanding of how the company has fared in this economically turbulent period. Forward P/E ranges from approximately 8-14, indicative of cheap valuation. With respect to the high ROE and low P/E multiples, you will note similarities between this screen and the methodology of Joel Greenblatt’s
Magic Formula and by the gentlemen at www.magicdiligence.com.
I am very visual, so there are four charts that I have created to visualize some simple profitability and valuation metrics before doing a deep dive into fundamental research of the companies listed.
To get a sense of how is the company’s durable competitive advantage is holding up, lets look at the five-year average ROE compared to the TTM value.
We note that both Microsoft (MSFT) and Walmart (WMT) are currently exceeding their five -year average. Most of the other companies are holding up nicely, with the exception of Bristol-Myers (BMS). Cisco (CSCO) has a marginal decline in ROE compared to its five-year average.
Next, let’s look at how current profit margins are holding up to the 5-year average. You will note the remarkable similarities in relative values that were found when comparing long term vs. current ROE.
With respect to valuation, the next two charts give us a visual of how forward P/E and P/B TTM compare to the five-year averages. All of these stocks appear to be attractively valued. Some may be cheap for a
good reason in that their long-term profitability has been attenuated; watch out for these value traps. Some, however, are likely to be truly great values.
Such a screen is by no means sufficient to purchase any of these equities, but it guides us to companies we want to dive into for in-depth research and helps us focus on value during a bumpy market.
For in-depth equity research reports and valuation models for wide-moat companies trading at a discount to intrinsic value, visit www.marginofsafetyportfolio.com
Disclosures: Long MSFT, CSCO
About the author:
We apply Buffett's and Charlie Munger's four filters in selecting stocks as part of a concentrated portfolio (10-15 equities). Criteria for selecting companies are:
1.They are strong businesses; as defined by high long-term cash generation, above-average return on invested capital, possession of favorable underlying economics and a durable ...More competitive advantage, good financial health, and above-average profit margins
2. We understand the business
3. They are run by competent management
4. They are available at bargain prices.
We require a 25-50% margin of safety, depending on the stability and economic moat for the company.
In addition to equity research services, we are a member of the Gerson Lehman Group Expert Counsel of Advisors and provide research/consulting services to investment banks.