Buffett looks at Mobil, then Wal-Mart

Model based on Warren Buffett's investment approach high on Exxon Mobil & Wal-Mart

By John Reese Dec 3, 2009 2:49PM

Warren Buffett. Image credit: © Chip East/ReutersGiven that I run a model portfolio based on Warren Buffett's strategy, I take a special interest when the Oracle of Omaha announces new purchases.

My Buffett-inspired model's picks don't always match up with his own buys -- the model focuses on the quantitative aspects of Buffett's approach that were disclosed eight years ago in the book "Buffettology," so non-quantitative factors (as well as possible evolution in Buffett's style since then) can make for some significant differences between my Buffett-based portfolio and Berkshire Hathaway's portfolio.


But there many times when a Berkshire buy will get high marks from my Buffett method, and that makes me sit up and take notice. And that was the case recently, when Berkshire announced its third-quarter holdings.


The disclosure revealed that Berkshire had taken a 1.28 million share stake in energy giant Exxon Mobil (XOM), and that it had almost doubled its stock in retail king Wal-Mart (WMT), adding about 18 million shares. And, according to Validea.com's Buffett-based Guru Strategy, Buffett was wise to do so.


First, let's look at Exxon. The $361 billion market cap behemoth gets a strong 86% score from my Buffett model, and a big reason is its impressive earnings history. The Buffett approach looks for a lengthy track record of rising earnings, because Buffett has found that persistent earnings growth allows him to better predict future earnings.

Over the past decade, Exxon has upped earnings per share in all but two years, and those two years came way back in 2001 and 2002, a very good sign.


Two other qualities Buffett is known to look for: a "durable competitive advantage" and strong management. And one way he has measured both of those qualities is return on equity.

My Buffett-based model requires a company to have produced an average ROE of at least 15% over the past decade, and Exxon easily makes the grade: Its 10-year average ROE is 25.2%.  


One more Buffett-like quality: manageable debt. My Buffett-inspired model looks for companies with enough annual earnings that they could, if need be, pay off all their debts within five years (preferably two).

Exxon has what for most firms would be a lot of debt -- $7.2 billion. But given that the company is raking in more than $20 billion in earnings per year, that debt doesn't seem very troublesome.


When it comes to Wal-Mart ($211.2 billion cap), the fundamental picture is also solid. The firm, which also gets an 86% score from my Buffett-based model, has upped EPS in every year of the past decade, showing exceptional earnings persistence.

And it has posted a 20.1% average return on equity over that period, a sign that it has both a durable competitive advantage (likely its size, name recognition, and/or low-cost reputation) and strong management.


When it comes to debt, Wal-Mart doesn't excel in the way that Exxon does. But it also isn't hamstrung by debt. The firm has about $37.6 billion in debt but $13.4 billion in annual earnings, meaning it could pay off its debts in a bit less than three years. That's not bad.


Wal-Mart and Exxon both also earn a bonus pass from my Buffett-based model because they've been repurchasing shares of their stock.

Buffett likes to see share repurchases because it adds to shareholder value, so my model looks for firms that have decreased shares outstanding over the past five years. In that timeframe, Exxon's shares outstanding have fallen from 6.4 billion to about 4.8 billion, while Wal-Mart's have dropped from about 4.2 billion to about 3.9 billion.


As great an investor as Buffett is, it's never wise to blindly follow the stock purchases of any manager, even one who has achieved "Oracle" status. But there's nothing wrong with using his picks as a starting point -- as long as you make sure that the ending point involves a strong fundamental and balance sheet assessment. In the case of Exxon and Wal-Mart, both firms appear to have the impressive track records and financial positioning that support Buffett's current interest in them.  

Full disclosure: I'm long XOM.


John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies."



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