Thursday, July 23, 2009

Warren Buffett Is a Growth Investor

Berkshire Hathaway's Warren Buffett is a value investor, right? Everyone knows that!

Well don't you tell that to Gerald Martin and John Puthenpurackal of American University and UNLV. In 2008, the two completed what they call "the first rigorous examination of Berkshire Hathaway's investment performance" -- a paper that analyzed not only the superior investment performance of Buffett, but also looked at his investing style.

Besides concluding that Buffett's superior investment returns since 1976 were more than just luck -- as if we didn't know that already! -- Martin and Puthenpurackal concluded that Warren Buffett is ... wait for it ... a large-cap growth investor.

The definition of growth that the researchers used was one that separates value and growth stocks based on the inverse of book value multiples and classifies value stocks as those with the highest book-to-market ratio and pegs those with the lowest as growth stocks. According to the paper, growth stocks accounted for more than 40% of Berkshire's investments, while true value picks made up less than 20% of Buffett's buys.

But let's not get too crazy here. After all, Buffett is still very much a value investor by his own definition -- that is, he only buys stocks that offer a discount to the company's intrinsic value. But what this study does suggest is that if we're looking for Buffett-esque stocks, our best bet is to look for high-quality companies rather than rummage through the bargain bin.

To track down some stocks that might fit the bill, I've enlisted the help of The Motley Fool's CAPS community and its stock screener. I focused my search on stocks that are returning 10% or more on their equity, are trading above book value, and have been highly rated by the CAPS community members. (You can run the same screen by clicking here).

Company

TTM Return on Equity

Book Value Multiple

CAPS Rating
(out of 5)

Gilead Sciences (Nasdaq: GILD)

43.7%

9.2

****

Oracle (Nasdaq: ORCL)

22.3%

4.4

****

Amgen (Nasdaq: AMGN)

20.4%

3.0

****

Raytheon (NYSE: RTN)

18.9%

1.9

****

Precision Castparts (NYSE: PCP)

21.5%

2.2

*****

Source: CAPS as of July 22, 2009.

While these aren't meant to be formal recommendations, they're a great place to kick off some research. In fact, why don't we start by taking a closer look at Precision Castparts.

The anatomy of a growth stock
Unless you work at or with the company, are an aerospace enthusiast, or are already an investor (or a member of Motley Fool Stock Advisor, where it's a recommendation), it's unlikely that you've run across Precision Castparts. As its name suggests, the company produces precision castparts -- complex metal structures formed in ceramic molds that go into products like aircraft engines and turbines, artificial hips, and parts for satellite launch vehicles.

Precision sells to a variety of customers; General Electric (NYSE: GE) and United Technologies subsidiary Pratt & Whitney are two of the largest and have each been customers for 30 years or more.

It's not a particularly exciting business and you're unlikely to impress people at a cocktail party by talking about molded metals (and if you do, I'm not sure you're at the right cocktail party). What is exciting though, is the performance of the company. As a dominant player in its niche, Precision has delivered strong top-line growth and has grown operating margins so they're now above 20%.

That's not to say that Precision hasn't hit some tough times with the rest of the market lately. Selling into the industrial and aerospace industries during a recession isn't an enviable position, and it hasn't helped that Boeing (NYSE: BA) seems to have two left feet when it comes to its much-awaited 787 Dreamliner.

CAPS or bust
Considering the rather brutal economic environment, I didn't think that the 13% drop in net income for the company's fiscal first quarter was bad at all. Impressively, the company managed to increase its profit margin from the prior year.

Precision's solid balance sheet is another bullish factor that's hard to overlook, and my fellow Fool Rich Duprey even noted that the Boeing false start may have created an opportunity on stocks like Precision.

I decided to give Precision a thumbs-up in my CAPS portfolio, and I'm far from alone -- nearly 1,300 other CAPS members have rated the stock an outperformer. CAPS All-Star TSIF joined the bullish chorus back in May, writing:

Precision Castparts Corp. continues to show that you can be in an industry that is affected by a recession, and if you are well managed and have a nice moat, you can still come out ahead. By specializing in complex components and special orders [Precision] has managed to keep it's margins up and it's balance sheets going up. ... Overall, coming out of a recession, it will be hard to beat companies such as Precision Castparts who showed their metal even in the worse of economic times.

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