For years now, Warren Buffett‘s name has been nearly synonymous with the term 'value investing'. A disciple of Benjamin Graham, the man known as the 'Father of Value Investing', Buffett has become the world’s most well-known investor thanks to his ability to ascertain the value of various securities and then buy them for less, a concept at the core of value investing. 'Price,' he has said, 'is what you pay. Value is what you get.'

But to label Buffett a 'value investor' is probably an oversimplification. In reality, his strategy involves several different factors. In fact, in a recent paper, three members of AQR Capital Management found that value is not what has driven Buffett’s success over the past few decades. 'The standard academic factors that capture the market, size, value and momentum premia cannot explain Buffett’s performance so it has to date been a mystery,' write Andrea Frazzini, David Kabiller, and Lasse H. Pedersen.

But in their study, they say, they 'find that the secret to Buffett’s success is his preference for cheap, safe, high-quality shares combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative draw downs this entails.'

They estimate that Buffett applies about 1.6-to-1 leverage, financed in part by the Berkshire’s insurance float. They also find that Berkshire Hathaway‘s public holdings over the 1980-2011 period averaged a beta of 0.77, meaning that they tended to be a good deal less volatile than the broader market.

After studying Buffett for more than a decade, I wasn't too surprised that high-quality, safer picks are responsible for his success. My Buffett-inspired share analysis strategy, which is based on the approach Buffett used to build his empire, puts just as much (if not more) emphasis on quality and stability than it does on value metrics, and quality shares tend to be less volatile.

My strategy looks for companies that have increased earnings per share in all or almost all years of the past decade at a stable rate; have enough annual earnings that they could, if need be, pay off all their debt within five years; and which have averaged returns on equity of at least 18% over the past 10 years–all signs of very high-quality businesses.

Whatever you want to call it, value investing, high-quality investing, low-beta investing high-quality-low-beta value investing, Buffett’s impeccable track record shows that his approach is well worth following.

Be Extraordinary!
Myles Rennie

Ever wonder what shares on the JSE Warren Buffett, Benjamin Graham and other Guru Value Investors would consider close to the perfect share? I have scanned the JSE using the investment strategies of various Value Investment Guru’s to answer that question. In total I used 6 different strategies by, respectively, Warren Buffett, Benjamin Graham, Peter Lynch, Martin Zweig, Kenneth Fisher, and James O’Shaughnessy. The reason I chose these gentlemen is because they are all considered Gurus of Value Investing past and present. Of the 6 Value Investors Buffett and Graham are considered more traditional, or patient, investors. Lynch, Zweig and O’Shaughnessy are all considered growth Value Investors and Fisher is considered a price-to-sales Value Investor. Although all the investment approaches of the investors listed stem from Benjamin Graham’s original approach, they all have their own unique approach to valuing shares.

The broad based scan of the JSE, using the 6 approaches, yielded some interesting results. Before sharing the results let me start with some general comments. I evaluated each share on the JSE using all 6 strategies and for each strategy I sampled the top ten shares based on the strategies’ screening criteria. Thus, from the evaluation I picked a total of 60 shares. However, many strategies sampled the same shares and therefore, amongst the 60 shares, only 39 unique shares were sampled. I found little correlation between the shares sampled using the different strategies, however, I did notice distinct differences between the shares selected by the growth versus the patient value investment strategies. Also, I noticed a high resource focus using the Peter Lynch strategy.

Every investor would love to own the perfect share. But did the screening find a share that is everything to all 6 the Guru investors? The short answer is no, but almost. The primary reason for this is the different focus areas, or approaches, of the different investors. The patient investors focus on balance sheet and income statement, whereas the growth investors are slightly more income statement focussed. Furthermore, if the strategies only had one or two criteria I would find many shares complying, but the strategies followed by these Gurus are comprehensive and include, amongst other, the following important criteria:

• Earning, Sales and Book Value. Most of the Guru’s focus on consistency and stability of year-on-year earnings, sales and book value. These are critical factors for all the patient investors.
  
• Money making opportunities. Return on equity helps measure how well a firm is finding opportunities to turn its resources into profitable business endeavours.
  
• Growth. Companies following an active reinvestment strategy show healthy revenue and EBIT growth. Furthermore, firms that grow while having ROICs higher than their cost of capital create value for shareholders at an accelerated pace. The patient investors focussed on firms that are within the mature growth to mature life cycle stages, whereas the growth investors picked shares that are within the growth to mature growth life cycle stages.
  
• Balance Sheet. At businesses with a lot of debt, banks and bondholders compete with shareholders for management's attention. Firms with strong balance sheets don't have to worry about the distraction of debt.
  
• Dividends. Firms with a strong balance sheet paying consistent dividends will yield great value over time, especially if it is done without sacrificing reinvestment and thus future growth.
  
• Ratios. Various ratios used for fundamental analysis play a key role and only firms with above average values per ratio are included in the samples.
  

Given these criteria, it would be unlikely that a single share would comply perfectly with the criteria of all 6 strategies, but there are a couple of shares, in fact only 5 from the entire JSE, that come very close. My guess is that you would expect to find these 5 shares listed in the Top 40 Index, but you would be wrong. On the contrary, it is more likely that you are unfamiliar with these 5 shares. From the 5 I picked my personal favourite, Bowler Metcalf (ticker symbol BCF). No share is a sure thing, but the 6 Guru’s and I think BCF is closer to perfect that many others. Let’s take a closer look at BCF by briefly analysing it based on the Buffett, Graham and Fisher valuation criteria.

I’ll start with Buffett’s criteria:

Next I analyse BCF using Graham’s criteria:

Finally I analyse BCF using O’Shaughnessy’s Cornerstone Growth Strategy criteria:

Based on the above these three Guru’s consider BCF to be one of the few perfect shares on the JSE. BCF also complies with at least 70% of the criteria stipulated by Lynch, Zweig and Fisher, which is why its one of the 5 ‘close-to-perfect’ value investing shares on the JSE. All this said, I am one with little faith and therefore, before making a decision to invest in a share, I apply some additional criteria. This includes a qualitative valuation of the firm’s management, competitive advantage, and finally an intrinsic valuation based on a discounted cash flow valuation. If I believe the share’s intrinsic value is close to, or at a discount to, its quoted share price I will purchase it in a heartbeat and hold on to it for as long as economics dictate.

Bowler Metcalf may not be perfect, but there are always some other shares you might like better. I encourage you to join an investment club and actively participate in screening, analysing and valuing firms in search of the perfect investment.

Be Extraordinary!
Myles Rennie