Taking Buffett's Strategy for a Test Drive

 | May 05, 2013 | 12:00 PM EDT  | Comments
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If you are a stock-market investor, you know that this weekend will be all things Warren Buffett. The Oracle of Omaha will hold his annual meeting for Berkshire Hathaway (BRK.A/BRK.B) in, of course, Omaha, Neb. -- and his acolytes will be there en masse

Many people who want to benefit from Buffett's insights have trouble buying into Berkshire for the simple reason that a single share of the A-class stock sells for about $160,000. But there is a way around this: Follow the advice of my Buffett-based strategy.

Years ago, I decided that the smartest way to invest is to follow the smartest people. I did that by reading about great Wall Street investment gurus and automating their strategies so I could immediately evaluate any stock on the basis of how these geniuses invest.

Of course, Buffett was high on my list of investors whose strategy I wanted to automate. Since I created this duplication of Buffett's strategy in December 2003, its stock picks have risen 81.1%, compared with a gain of 49.1% for the S&P 500 during the same period. Enough said.

Most recently, I have found two retailers and a retailer/manufacturer -- large and well priced -- that get very high marks from my Buffett-based strategy. If you want to benefit from Buffett's approach to investing, but lack the money to buy many Berkshire Hathaway shares, these three companies could prove to be good proxies.

TJX Companies (TJX) operates such off-price stores as T.J. Maxx and Marshalls, and it is by far the largest player in its market. A major TJX competitor that also gets high grades from the automated Buffett strategy is Ross Stores (ROST), which operates under the Ross Dress for Less moniker. The third is on the other end of the price spectrum from TJX and Ross. It is Coach (COH), maker of handbags, footwear and other items, which it sells through its own stores as well as department stores and other retail outlets.

Buffett prefers companies that have a "durable competitive advantage," meaning the possession of name brands, size, patents or other advantages that are difficult to dislodge. These companies are typically at the top of their markets or No. 2. All three of the companies I mentioned hold such competitive advantages, along with great name-brand recognition and dominant size.

The strategy looks for earnings predictability, since investors do not like surprises. Such predictability is shown when earnings per share increases in all or most years for a long time period. TJX's earnings per share has risen in each of the last 10 years, while Ross and Coach have enjoyed increasing EPS for nine out of the last 10 years.

Debt is not Buffett's favorite way of operating, so the strategy looks for moderate to no debt. TJX and Ross have very moderate amounts of debt, while Coach has virtually none. Also valued is a high return on total capital, which demonstrates that the company is using its capital effectively. All of these companies have impressive ROTC, with Coach leading the way (39.6%) and TJX and Ross not far behind (29.9% and 29.3%, respectively).

The strategy also looks at estimated annual investor returns over the next decade. Here again, these three companies are standouts. TJX is expected to return 17.4%, Ross 16.4% and Coach 20.8%.

As you think about Buffett and his track record this weekend, consider buying any or all of these high-performing companies. You do not have to be rich enough to buy Berkshire stock to benefit from Buffett's thinking.

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