Warren Buffett never expounded extensively on his investment approach, although it can be gleaned from his writings in Berkshire Hathaway annual reports. AAII was inspired by the approach presented by Robert Hagstrom in “The Essential Buffett” (John Wiley & Sons, 2001) to develop a quantitative screen for Buffett stocks.

The Hagstrom Buffett approach is available for AAII members in the Stock Ideas section of AAII.com and is also built into AAII’s fundamental stock screening and research database, Stock Investor Pro. This First Cut presents the exchanged-traded, domestically listed stocks that pass the filter.

The First Cut begins by seeking companies with a consistent operation history as measured by operating profits. Companies must have positive operating income for the trailing 12 months and each of the last seven fiscal years.

The First Cut requires return on equity (ROE) greater than 15% for the current period and each of the last three fiscal years as well as operating margin and net profit margins greater than the respective industry median to reflect Buffett’s preference for companies that have defensible market share.

As a measure of financial strength, the First Cut looks for companies with a ratio of current debt-to-equity better than the industry median. Buffett favors larger companies, so the First Cut requires a market cap of at least $1 billion dollars.

Buffet seeks out companies managed with shareholder interests in mind. The First Cut requires at least a dollar-for-dollar share price increase for each dollar added to retained earnings from the income statement over the last five years.

The final filter examines valuation: Since Buffett likes to focus on free cash flow, the price-to-free-cash-flow ratio is used. Lower is better; however, to adjust for varying growth rates, the price-to-free-cash-flow ratio was divided by the free-cash-flow growth rate to help equate value to growth (P/FCF to FCF growth field). The 25 companies with the lowest ratios of free-cash-flow multiple to growth rate made the First Cut.
—John Bajkowski, AAII president

Hagstrom Essential Buffett Stocks Ranked by Price-to-Free-Cash-Flow to Growth

Criteria for Use in SI Pro

	Field:	Operator:	Compare to:
Exchange	Not Equal	Over the counter
And	ADR/ADS Stock	Is False
And	Industry	Not Equal	Misc. Financial Services
And	Industry	Not Equal	Real Estate Operations
And	Market Cap Q1	>=	1000
And	Gross operating income 12m	>	0
And	Gross operating income Y1	>	0
And	Gross operating income Y2	>	0
And	Gross operating income Y3	>	0
And	Gross operating income Y4	>	0
And	Gross operating income Y5	>	0
And	Gross operating income Y6	>	0
And	Gross operating income Y7	>	0
And	Return on equity 12m	>	15
And	Return on equity Y1	>	15
And	Return on equity Y2	>	15
And	Return on equity Y3	>	15
And	Operating margin 12m	>	Industry Operating margin 12m
And	Net margin 12m	>	Industry Net margin 12m
And	LT Debt/equity Q1	<	Industry LT Debt/equity Q1
And	Price Chg vs BV Chg	>	0
And	PFCF to FCF growth	>	0
And	PFCF to FCF growth	<=	1.7