Opinion: Warren Buffett’s investment prowess will last forever after researchers crack his investment code

If you are an investor in Berkshire Hathaway Inc. Your performance will not be affected when Warren Buffett stops running the company.

That’s according to researchers who claim to have created a stock picking algorithm, which, in back tests, performed just as well as Berkshire Hathaway.

Having this algorithm is important for at least two reasons. Perhaps most telling, Buffett, who turns 92 in August, will not be picking stocks forever. His followers urgently need to know what to do when he stops doing it.

Read: Once again, Warren Buffett and Berkshire Hathaway outperform the stock market

At last year’s Berkshire annual meeting, Buffett indicated he had chosen Greg Appel, now the company’s vice president, as his successor. In a 2013 video message, Buffett said that Abel is “a first-class human being. …There are a lot of smart people in this world, but some of them do very stupid things. He’s a smart guy who would never do something stupid.”

To the extent that you are confident that the company’s stock picking under Abel will be as good as it was under Buffett, your response to Buffett’s stepping down may be to continue down the path.

But there’s another reason to know that Buffett’s approach to stock picking can be replicated: Berkshire Hathaway is so huge that neither he nor Abel can bother even thinking about smaller companies that would otherwise capture their attention.

See also: Berkshire and Buffett have five words for sellers who want their money: “Take it or leave it.”

Although the potential of these smaller-cap stocks is usually greater than that of larger-cap stocks, their size prevents them from contributing more than an approximation to Berkshire Hathaway’s bottom line.

This second reason suggests that it may be possible in the coming years to not only do Berkshire Hathaway’s job, but perhaps even do a better job — no matter how long Buffett remains the company’s CEO.

The researchers who “broke the Buffett Code,” all with strong academic credentials, are the directors of AQR Capital Management: Andrea Frasini, David Cappeller and Lacey Pedersen. Their study reporting this algorithm appeared in the Financial Analyst Journal in 2018, titled “Buffett’s Alpha.” (A request for comment on this study from Berkshire Hathaway was not immediately answered.)

The details of the algorithm derived by the researchers are complex, and interested readers should refer to the study for a full description. In general, the algorithm focuses on what might be called “cheap, safe stocks” — those that have low P/B ratios, have shown below-average volatility, are companies whose earnings have grown above-average pace and that pay a portion a large portion of its profits as profits.

The proof of the pudding is the eating, of course. The researchers’ study began circulating in academia in late 2013, and I wrote a column about it in December 2013. It specifically mentioned an AQR common fund perhaps the one that closely follows the researchers’ algorithm – the AQR Large Cap Defensive Style Fund AUEIX,
-3.26%.
Since then, Buffett’s performance has closely matched, gaining 13.1% annually versus Berkshire Hathaway BRK.B’s 13.5%.
-2.55%.

To illustrate what type of stocks meet the algorithm, here are those stocks in the S&P 1500 that meet a number of criteria for the algorithm defined: each with a below-average price-to-book ratio, below-average beta, above-average profitability, And above-average five-year growth rate of its profitability, and above-average dividend payout ratio. (All data provided by FactSet.)

The sixteen stocks that survived this winnowing process are listed below, in alphabetical order:

ribbon

stock

AVD

American Vanguard Corp.

kato

KATO Class A company

CMCSA

Comcast Corp Class A

X ray

DENTSPLY SIRONA, Inc.

EPC

Edgewell Personal Care

FCFS

FirstCash Holdings Inc.

HWKN

Hawkins Corporation

INTC

Intel Corp.

JNPR

Juniper Networks Inc.

died

Matthews International Corp. Class A

NWL

Newell Brands Inc.

RGP

Resources Connection Inc.

SPTN

Spartan Nash Corporation

Tg

Tredegar Corp.

UGI

UGI Corporation.

WBA

Walgreens Boots Alliance Inc.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert rating tracks investment newsletters that pay a flat fee to review. He can be reached at mark@hulbertratings.com.

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