Warren Buffett caught the investment world's eye this week, revealing that his Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) has been building a $10-billion-plus position in tech giant International Business Machines (NYSE:IBM) over the past few quarters, as well as the smaller stake in fellow tech firm Intel Corp. (NASDAQ:INTC).
The moves were big surprise to many, since Buffett has long been hesitant to invest in tech companies, preferring instead to target firms with simpler, easy-to-understand businesses. In Berkshire's 1999 letter to shareholders, he explained his tech sector reticence this way: "We share the general view that our society will be transformed by their products and services. Our problem -- which we can’t solve by studying up -- is that we have no insights into which participants in the tech field possess a truly durable competitive advantage."
While Buffett's IBM move was surprising given such comments, it wasn't all that surprising if you look at the fundamentals -- which are what my Buffett-inspired Validea.com "Guru Strategy" does. Based on the book Buffettology, written by Buffett's former daughter-in-law and colleague Mary Buffett, my Buffett-based model identifies stocks that have the quantitative characteristics Buffett looked for while building his empire. It doesn't always jive with Buffett's real-time moves, since the Oracle of Omaha no doubt takes non-quantitative factors into account when investing. But in the case of IBM, it was on the money. Throughout much of this year, as Buffett has been building Berkshire's IBM position, my Buffett-based approach has been giving the stock very solid marks.
What did my Buffett strategy -- and perhaps Buffett himself -- see in IBM? One thing is that IBM isn't a flash-in-the-pan-type tech stock. The company was first incorporated 100 years ago, and it has a lengthy history of producing steadily increasing earnings -- something my Buffett-based model loves to see. The firm has upped earnings per share for 8 straight years, and it's on track to do it again in 2011.
IBM has also averaged a return on equity (ROE) of 27.5% over the past decade. That's nearly twice my Buffett-based model's 15% target -- and return on equity is one measure Buffett has used to assess whether or not a company has that "durable competitive advantage" that he so cherishes. IBM also has enough annual earnings that it could pay off all its debt in less than two years, if need be, which this model considers exceptional.
So, while it's a tech firm, IBM has demonstrated the type of consistent long-term performance typical of Buffett investments. And it hasn't been the only tech company doing so. In fact, more than a third of the companies that my Buffett-based model currently gives a score of 99% or 100% are tech stocks. I certainly don't expect Buffett's IBM and Intel buys to trigger a tech stock buying binge for Berkshire. But these five tech firms have the fundamental characteristics Buffett looked for while building his empire, which makes them worth a long, hard look for any investor.
Infosys Technologies (NYSE:INFY): Based in India, this global I/T giant gets about two-thirds of its revenue from North America. The $32-billion-market-cap firm has taken in more than $6.6 billion in sales in the past year, and it gets a perfect 100% score from my Buffett-based model. A few key reasons: It has upped EPS in each year of the past decade, has no long-term debt, and has averaged a 30.2% ROE over the past ten years. Its shares aren't dirt cheap, but its earnings yield -- just north of 5.1% -- is well above the yield on long-term Treasury bonds, something my Buffett model likes to see.
FactSet Research Systems Inc. (NYSE:FDS): Connecticut-based Factset provides global financial and economic data and analytical applications to a variety of customers in the financial world. The $4.4-billion-market-cap firm gets a perfect 100% score from my Buffett-inspired model, thanks in part to its having upped EPS in each year of the past decade. It also has no long-term debt and is averaging a 26.5% ROE over the past decade. FactSet isn't cheap -- its earnings yield is just 3.81%. But my Buffett-based model thinks that, given its long-term track record and exceptional balance sheet, it's worth it.
Oracle Corporation (NYSE:ORCL): I wrote about this California-based, one-stop-shopping tech giant back in July because my Buffett-based model was high on it. Since then it has outperformed the broader market by about 3.5 percentage points, and the Buffett approach remains a fan, giving the stock a 99% score. Oracle has upped EPS in each year of the past decade, and it has averaged a 26.2% ROE over that period. It has more debt than Infosys or FactSet -- $14.8 billion to be exact -- but it could use its $9.1 billion in annual earnings to pay off that debt in less than two years if need be, which this model still considers exceptional. Oracle shares have a 5.5% earnings yield, which is reasonable given its strong fundamentals and track record.
Syntel, Inc. (NASDAQ:SYNT): This I/T firm is based in Troy, Mich., and gets most of its revenues from North American sources, though most of its employees are located in India. The firm is probably too small ($2 billion market cap) for Buffett's giant Berkshire Hathaway to be able to make a meaningful investment in it, but its financials and track record are distinctly Buffett-esque, earning the company a 99% score from my model. The firm has upped EPS in all but two years of the past decade, has no long-term debt, and is averaging a 26.7% ROE over the past ten years. Management has also earned shareholders a 28.4% return on retained earnings (that is, earnings the company didn't pay out as dividends) over that period, more than doubling this model's 12% target. And, its earnings yield of about 5.6% is more than 2 percentage points above the yield on long-term Treasuries.
Microsoft Corporation (NASDAQ:MSFT): Buffett and Bill Gates have become good friends and partners in philanthropy over the years, and my Buffett-based model also thinks Gates' firm is a good match with Buffett's investing approach. The $225-billion-market-cap tech giant has upped EPS in all but one year of the past decade and its debt ($11.9 billion) is only about half of its annual earnings ($23.3 billion). It has also averaged a 29.3% ROE over the past ten years. In addition, it's much cheaper than the other stocks we've examined, selling at an earnings yield of 10.55%.
Microsoft gets a lower score than those other stocks -- 86% -- however, but that's really more of a technicality than a legitimate flaw. That's because, in addition to requiring an average 15% ROE over the past decade, the model requires a firm's annual ROE to be at least 10% in each year of that period; Microsoft fell ever-so-slightly short of that way back in the very first year of the past decade, with an ROE of 9.9%. If not for that, it might be the most "Buffett-esque" stock of any of these five.