What are we looking for?
With the recent market pullback, let's look for some bargain-priced stocks with long-term potential.
We'll use Validea Canada's "Patient Investor" screen, which emulates the stock-picking methods of Warren Buffett. The screen is based on the book Buffettology, written by the Oracle of Omaha's former daughter-in-law, Mary Buffett.
The screen "is the only one of our strategies that is not taken directly from the writings of the guru himself, as Buffett has yet to write about his investment strategies" in detail, Validea says. We'll use the screen to look for Canadian companies. (Globe Investor has a joint venture with Validea.ca, a premium Canadian stock screen service.)
The screen has produced some impressive results. Validea's Patient Investor model portfolio has posted a return of 89 per cent from inception on Aug. 6, 2010, through Oct. 21, 2014. That's the highest return of any of its model portfolios and is more than triple the return of the S&P/TSX composite index over the same period. (Returns are based on price changes alone and do not include dividends.)
Validea's model portfolio is rebalanced monthly to include the 10 stocks that score highest on the Patient Investor screen. The 10 stocks listed with this column are those that would be included in the portfolio if the rebalancing happened on Oct. 22. (The actual rebalancing will take place on Oct. 24.)
More on the methodology
Mr. Buffett aims to buy solid businesses at "fair" prices and often holds stocks for decades, Coca-Cola Co. and American Express Co. being two examples. He summed up his investing philosophy in his 1996 letter to Berkshire Hathaway shareholders: "Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10 and 20 years from now.
"Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."
In the table, the "strategy score" indicates the degree to which the stock met the criteria in the Patient Investor screen.
Validea's "long-term EPS growth" number is an average of the three-, four- and five-year annualized growth rates, to smooth out the effects of one exceptionally good or bad year.
The PEG ratio is the price-earnings multiple divided by the long-term earnings growth rate. Generally, the lower the PEG, the more attractive a stock is from a valuation standpoint.
A word of caution
A stock screen is only a first step in the investing process. Be sure to do your own due diligence before investing in any company.