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The five stocks I will describe here are the top growing stocks in Warren Buffett's portfolio. I like to concentrate on enterprises that attain good returns on equity while incurring little to no debt. Companies that are highly leveraged are vulnerable in the event of an economic slowdown. I find that Buffett follows this concept, which is why I find it interesting to analyze his main choices to derive well thought-out seed investment ideas.

IBM

International Business Machines Corporation ((NYSE:IBM)), incorporated in the State of New York during 1911 as the Computing-Tabulating-Recording Co. (C-T-R), had its name changed to the International Business Machines Corporation in 1924. The company develops and manufactures advanced IT, like software, computer systems, storage systems as well as microelectronics. Its most important operations are classified as the Global Business Services (GBS) segment, the Global Technology Services (GTS) segment, the Systems and Technology segment, the Software segment and the Global Financing segment.

I believe that Buffett invested in the company because its healthy growth shows a resolution to execute high-value productivity initiatives providing rather longer-term benefits, including its conversion into a worldwide integrated business. The company focuses usually on high-growth and high-value segments of the information technology industry. Its growth measures, which include its smarter industry and planet frameworks, business analytics, growth markets and optimization as well as cloud computing, seem to drive considerable growth and generate high profit margins. Such initiatives are expected to provide at minimum $50 billion in revenue by the fiscal year of 2015. The firm expects to create smarter planet and commerce revenue in the amount of $10.0 billion as well as $20.0 billion, respectively, by the year 2015. Furthermore, business analytics are expected to provide $16.0 billion, while at the same time cloud-computing will most likely deliver about $7.0 billion in revenue by the year 2015. I remain optimistic regarding IBM's long-term growth and thus reckon that it will publish stronger results, assisted by its own initiatives in such fields. The data center solution as well as the cloud computing measures are also bound to drive growth. The company leads in the middleware business, having a market share of 33.0%. Among the company's middleware products, one could mention Websphere, Tivoli, Lotus and Rational, which are employed to connect numerous types of software systems. Due to its investment of more than $60.0 billion in research and development since the year 2000, IBM has managed to build an analytics solution center, business resilience service delivery centers as well as cloud computing centers throughout the world. I believe that such centers will help the company to raise its revenue going forward.

Another factor behind Buffett's choice is that the company's restructuring measures are progressing and have resulted in an enhanced bottom line. Furthermore, such a combination of a better business mix, enhancing operating leverage by means of productivity gains and a higher investment in growth opportunities will most definitely increase growth during 2011 and beyond. The firm is planning to implement efficiencies, to reinforce client-facing activities and to explore opportunities in high-growth markets, mainly including the voluntary and involuntary workforce reductions. During 2010, the firm's expense-to-revenue ratio has fallen by 50 basis points, which has in turn driven a gross margin growth of about 40 basis points. Most reductions were linked to the Global Services segment, mainly in Europe, not to mention the vacation of those leased facilities. Such actions were added to the firm's constant workforce reduction as well as its rebalancing activities, which have raised productivity in all quarters. According to these initiatives, IBM attained cost savings of $6 billion during the last five years (from 2006 until 2010). The company is expecting to save $8 billion by the year 2015 according to improvement in general efficiency, which will also expand the bottom line by nearly $5 billion.

The current net profit margin of IBM is 14.83, which is lower than its 2010 margin of 14.85. I do not like it when companies have profit margins that are lower than past ones. In itself, that factor could be a reason to analyze why it happened. Its current return on equity is 73.43. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of 64.94.

In terms of income and revenue growth, IBM has a 3-year average revenue growth of 1.05 and a 3-year net income average growth of 8.73. Its current revenue year over year growth is 7.05, higher than its 2010 revenue growth of 4.30. The revenue increase from last year shows that the business is now performing well. The current net income year-over-year growth is 6.89, lower than its 2010 average of 10.49. I do not like it when current net income growth is lower than the past year. I usually look for companies that increase both profits and revenue.

In terms of valuation ratios, IBM is trading at a Price/Book of 11.8x, a Price/Sales of 2.3x and a Price/Cash Flow of 12.6x in comparison with its industry averages of 5.3x Book, 2.0x Sales and 10.6x Cash Flow. It is fundamental to analyze the company's current valuation and check how it is trading in relation to its peer group.

In terms of valuation, IBM stock has surged 23% a year to date in comparison to a 2.2% decline in the S&P 500 (NYSEARCA:SPY). Its current trailing 12-month earnings multiple stands at 14.2X, in comparison to the 18.9X average for the peer group and the 16.9X for S&P 500. During the most recent five years, shares have been trading in the range of 9.4X to 18.3X trailing 12-month earnings. As such, it is now trading barely above the midpoint of its historical range, which reflects a limited upside from its current levels.

The firm is currently trading at 13.6x the 2011 earnings per share estimate, which thus represents a discount to peer group but a premium to the S&P 500. The firm's current 31.3% discount to peer group during 2011 is barely lower than its 44.5% average discount for its historical period, which reflects a number of downside risks. Furthermore, investment in the firm is expected to create 10.7% during the following five years, in comparison to the 18.5% peer group average. Consequently, I believe that such discount attributed to the stock is indeed justified. I also do believe that the firm is a basically sound company with a very strong market position, yet I would still caution based on these valuation considerations. Naturally, I remain optimistic about the firm's long-term growth, but its increasing competition may prove to be a drag on its results.

The firm has approximately $17 billion in cash as well as equivalents and is nearly $31 billion in debt. IBM creates enough cash from operations to fulfill its debt obligations, as it keeps investing in growth opportunities.

DaVita (NYSE:DVA)

Established in 1994 and based in Denver, Colorado, DaVita Inc. is one of the leading providers of dialysis services in America to patients who suffer from chronic kidney failures, also known as the "end stage renal disease" (ESRD). The firm is operating kidney dialysis centers and providing relevant medical services mainly in dialysis centers as well as in contracted hospitals throughout the U.S. The firm's services include, among others, hospital inpatient dialysis services, outpatient dialysis services as well as ancillary services like disease management and ESRD laboratory services.

The company's dialysis and relevant lab services business segment (about 93% of its consolidated net operating revenue during 2011) offers routine laboratory testing for ESRD patients, inpatient and outpatient dialysis services and administration services to outpatient dialysis centers. The firm's ancillary services and strategic initiatives (about 7%) both include the firm's international dialysis services, infusion therapy services, pharmacy services, vascular access services, disease management services, ESRD clinical research programs as well as physician services.

I reckon that Buffett was attracted by the reality that the firm has been creating a strong operating cash flow that has accrued from enhanced earnings, strong cash collections as well as the timing of payments as regards working capital expenditures. Operating cash flows have been raised at a 3-year CAGR (from 2008 until 2011) of 24%. A similar growth is to be expected in the future based on the firm's operating cash flow guidance of $0.95 to 1.05 billion. The company's strong cash flows enable it to satisfy its capital expenditure needs and repurchase shares and to spend a portion thereof on acquisitions. The firm has repurchased shares worth $323.4 million during the first half of the year 2011, even though it had not repurchased any shares during the second half of the year 2011, so as to maintain a cash level necessary for acquisitions in a volatile debt market. As of December 31 of 2011, the firm's stock worth nearly $358 million remained available for repurchasing, which reflects the company's quite fair liquidity status.

A second reason supporting Buffett's pick is that the company consistently seeks to create cost efficiencies. While its long-term Epogen purchase with Amgen Inc. has barely increased the cost of Epogen during the near term, the transaction will be significantly reducing the firm's future expenditure on this drug. Even though the firm had not disclosed the financial terms of the transaction, it is to be expected that the company received important discounts as well as rebates under the agreement, which did prompt it to enter a seven-year transaction although Epogen's patent will be expiring during 2014 and low-cost competing products will become available in the market by then.

The current net profit margin of DVA is 6.85, which is higher than its 2010 margin of 6.29. I usually seek companies that have raised their profit margins in comparison to other years. Thus, I find it is vital to know why that happened. Its current return on equity is 23.21. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of 19.72.

In terms of income and revenue growth, DVA has a 3-year average revenue growth of 7.25 and a 3-year net income average growth of 8.51. Its current revenue year-over-year growth is 8.45, higher than its 2010 revenue growth of 5.39. That revenue rose from last year demonstrates that the business is now performing well. The current net income year-over-year growth is 17.83, higher than its 2010 average of -4.02. I consider it favorable when net income growth is higher than the past.

In terms of valuation ratios, DVA is trading at a Price/Book of 3.9x, a Price/Sales of 1.2x and a Price/Cash Flow of 7.2x in comparison to its industry averages of 3.3x Book, 0.6x Sales and 5.8x Cash Flow. It is most important to examine the company's current valuation and check how it is trading in relation to its peer group.

With regard to valuation, the firm's stock now trades at 13.8x of the 2012 earnings estimate, an 11% premium over the 12.4x industry average. On a price-to-book basis, the stock is trading at 3.8x, a 65% premium over the 2.3x industry average. Its valuation on a price-to-book basis also seems rather attractive, on account of the trailing 12-month ROE of 22.4%, which is considerably over and above the 15.6% industry average.

The company's acquisitions in the past few years have raised its leverage, as the firm had debt of nearly $4.5 billion against $575 million of cash as well as investments during September. The company has managed to offset the rise in leverage by generating a strong cash flow.

General Dynamics (NYSE:GD)

Based in Falls Church, Virginia, the General Dynamics Corporation is engaged in: mission-critical technologies and information systems; armaments and munitions; land and expeditionary combat vehicles; business aviation as well as shipbuilding and marine systems. The firm is active in four segments: Combat Systems, Marine Systems, Information Systems & Technology (IS&T) and Aerospace. This IS&T segment includes secure communication networks and systems as well as control, command and intelligence systems. The Combat Systems segment is responsible for manufacturing medium-caliber guns, combat vehicles, ammunition as well as ammo handling systems. In turn, Marine Systems produces surface combatants, nuclear submarines as well as auxiliary ships. Finally, the Aerospace segment involves Gulfstream Aerospace, which produces business jets, while General Dynamics Aviation Services offers aircraft spare parts and maintenance.

I am positive that Buffett researched the fact that the firm was ranked as the third-largest U.S. defense contractor in revenue terms during fiscal year 2011, ranking just after Boeing (NYSE:BA) and Lockheed Martin (NYSE:LMT). The firm is one of the two contractors that are prepared to construct nuclear-powered submarines in the United States. Its revenue exposure is usually spread over a wide portfolio of services and products in combat vehicles, business aviation, weapons systems and munitions; shipbuilding design, construction and repair; as well as information technologies, systems and services. The diversification of its revenue by means of exposure to certain uncorrelated markets is bound to keep steady the firm's overall growth momentum.

A further element contemplated by Buffett's analysis is that the company's working capital improvements remain impressive, as evidenced by its inventory turnover of 11.3 times by the end of the fiscal year 2011, in comparison to the only 3.3 times for the average analyst estimate, which shows a strong sign of the firm's operational efficiency. The company's operational effectiveness is also visible through its high ROI, which was at 15.9% by the end of the fiscal year 2011 in comparison to the 6.1% average analyst estimate.

The current net profit margin of GD is 7.73, which is lower than its 2010 margin of 8.08. I do not like it when companies achieve lower profit margins than in the past. Among others, it could prove to be a reason to analyze why that took place. Its current return on equity is 19.03. It is lower than the 20% standard I look for in companies I invest in. It is also lower than its 2010 average return on equity of 20.39.

In terms of income and revenue growth, GD has a 3-year average revenue growth of 3.70 and a 3-year net income average growth of 0.90. Its current revenue year-over-year growth is 0.65, lower than its 2010 revenue growth of 1.52. I am not in favor of having current revenue growth be lower than the one in the past year. Usually, it goes to show that its business seems to be slowing down for some reason. The current net income year-over-year growth is -3.73, lower than its 2010 average of 9.61. I do not prefer companies with a current net income growth lower than the one in their past year. I generally target companies that manage to increase both profits and revenue.

In terms of valuation ratios, GD is trading at a Price/Book of 2.0x, a Price/Sales of 0.8x and a Price/Cash Flow of 8.3x in comparison to its industry averages of 3.3x Book, 0.9x Sales and 10.2x Cash Flow. It is necessary to analyze the company's current valuation and check how it is trading in relation to its peer group.

Valuation is at the heart of any investment decision. I consider the company a well-run firm likely to keep fulfilling expectations, as it is driven by margin expansion, revenue growth as well as cash flow creation. Looking forward, the most important drivers include the revival of the jet business (Gulfstream), a solid business for U.S. military vehicles (Abrams tanks and Stryker combat vehicles), with more than $57 billion in backlog, an ongoing share repurchasing program as well as the creation of a strong cash flow. Nonetheless, the firm's fortunes depend largely on the American defense budget, which is threatened by budget cuts. In addition, I am cautious as regards the firm's constantly-falling order backlog, not to mention the risks linked to the implementation of its main projects. The company's current trailing 12-month earnings multiple is 10, in comparison to the 10.7 average of the peer group and the 14.5 of S&P 500. The stock trades at a discount to the peer group and to S&P 500, which is based on advance earnings estimates. During the most recent five years, the shares have been trading within the narrow band of 6.5X to 18.9X trailing 12-month earnings, in comparison to the 5.9X-26.5X of its peer group.

The firm remains in solid financial health with a total debt of $7.5 billion (including about $3.6 billion in retirement liabilities as well as $3.9 billion of long-term debt) plus $1.5 billion in cash. Thus, the firm generates $3 billion in operating cash flow every year and requires about $1.1 billion in order to cover its capital expenditure and dividend needs. The firm keeps boasting a strong financial flexibility despite having reduced its share count by 10% in the five most recent years.

Wal-Mart (NYSE:WMT)

With its headquarters in Bentonville, Arkansas, Wal-Mart Stores, Inc., established in 1945, is operating retail stores in several formats throughout the world. The firm is conducting businesses in three segments: Walmart U.S., Sam's Club and International. Its Walmart U.S. division has accounted for 63.8% of the company's 2010 net sales of about $405 billion. This segment is operational in retail stores of several formats across the United States, not to mention Walmart's online retail operational site, walmart.com. The firm's International segment basically consists in retail operations within 14 countries as well as Puerto Rico. Such segment does include diverse formats of retail stores as well as restaurants. The diverse formats also include discount stores, supercenters as well as Sam's Clubs operating outside the U.S. The division has managed to generate 24.7% of the firm's fiscal 2010 net sales. The firm and its subsidiaries have employed nearly 2.1 million employees worldwide, with about 1.4 million employees in the U.S. as well as 700,000 at an international level as of January 31 of 2010. Wal-Mart's fiscal year ends on January 31.

In his investment thesis, I deem that Buffett probably saw that the firm earns customer trust daily by providing a wide assortment of quality goods and services at everyday low prices (EDLP), which is the firm's pricing philosophy: it prices items at a low price every day, which assures customers that prices shall not change under quite frequent promotional activity.

Moreover, I am sure that Buffett's research analysis showed that the firm holds a strong presence in the international market. Its international segment is made up of retail operations within 14 countries as well as Puerto Rico. In the international segment, total sales have come in at $100,107 million in the fiscal year 2010, up 1.3% year over year, while they have been raised by 20% to $32.4 billion in its third quarter, which includes the benefit from acquisitions as well as currency exchange translation. The firm's important international presence has been boosting growth, which leads me to believe that such growth momentum will be preserved in the upcoming years.

The current net profit margin of WMT is 3.89, which is higher than its 2010 margin of 3.51. I am positive about companies that have amplified their profit margins when compared with previous years. As such, I deem it relevant to understand the cause behind such a result. Its current return on equity is 23.53. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of 21.08.

In terms of income and revenue growth, WMT has a 3-year average revenue growth of 3.68 and a 3-year net income average growth of 8.78. Its current revenue year-over-year growth is 3.37, higher than its 2010 revenue growth of 0.92. Revenue rose from last year, so the business is most likely performing well. The current net income year-over-year growth is 14.05, higher than its 2010 average of 7.24. I like it when net income growth is higher than the past.

In terms of valuation ratios, WMT is trading at a Price/Book of 3.1x, a Price/Sales of 0.5x and a Price/Cash Flow of 8.8x in comparison to its industry averages of 3.1x Book, 0.5x Sales and 9.2x Cash Flow. It is necessary to study the company's current valuation and check how it is trading in relation to its peer group.

Concerning valuation, the shares are now trading at 13.0x of earnings estimate of 2012, a 11.0% discount over the industry average of 14.6x. As regards the price-to-book basis, shares are trading at 2.7x, a 3.8% premium over the 2.6x industry average. The company's valuation on a price-to-book basis seems fair, on account of a trailing 12-month ROE of 21.8%, considerably ahead of the 15.8% industry average. The six-month target price of $61.00 per share is equated to nearly 13.6x of the earnings estimate of 2012. With an annual cash dividend of $1.46, the target price means an expected total return of 5.8% during such period.

I fail to see any liquidity issues within Wal-Mart. I estimate about $55 billion in free cash within the following five years against nearly $20 billion in debt maturities which will be due within the same time frame. The firm has also over $7 billion in cash on its balance sheet and also manages to maintain a $14 billion credit facility. The firm's rent-adjusted fixed coverage ratio now stands at more than 17 times, which is quite above most debt covenant requirements. The firm owns most of its stores and enjoys more than sufficient liquidity going forward, even should a more complicated operating environment take place.

CVS Caremark Corporation (NYSE:CVS)

CVS Caremark Corporation, based in Woonsocket, Rhode Island, is one of the largest providers of prescriptions as well as related healthcare services within the U.S. This firm, one of the largest providers of domestic integrated pharmacy services, is active in the segments of Pharmacy Services and Retail Pharmacy.

By the end of the fiscal year 2011, CVS was operating 7,404 locations, which included 30 onsite pharmacies, 7,327 retail drugstores, 12 specialty mail order pharmacies, 31 retail specialty pharmacy stores as well as 4 mail order pharmacies within 44 states, the District of Columbia and Puerto Rico.

Why did Buffett decide to invest in CVS? For the most part, I remain optimistic as regards the domestic demographic trends, which will most likely drive utilization rates for many years to come while the relevant population ages. Therefore, retail pharmacy operators such as CVS will be able to expand and recapture their market share. Moreover, the firm's mail order service is winning popularity, which will assist in offering more top-line opportunities. The firm has taken steps to make prescription drugs even more affordable to its consumers. A number of these programs are Maintenance Choice (a flexible option for fulfillment that offers patients the choice of taking their 90-day supply of maintenance meds from CVS pharmacy stores or procuring them by mail order at the only cost of mail for both payer and patient); Bridge Supply (which allows patients to avert gaps in care while waiting for their meds to arrive in the mail, as they can obtain a bridge supply of prescriptions from CVS pharmacy stores free of charge) and an ExtraCare Health Card program (which provides discounts on a number of Flexible Spending Account-eligible as well as over-the-counter healthcare products that are sold at CVS pharmacy stores). Furthermore, in light of the anticipated launching of the Maintenance Choice 2.0, CVS is expecting that the number of its clients to accept this offer will increase considerably over the upcoming years. The generic substitution of drugs is an important factor in reducing prescription healthcare costs. Generic drugs, considered as a percentage of total prescriptions, are an increasingly more common phenomenon. As such, this is likely to rise even further as the patents of numerous important pharmaceutical products are set to expire over the following 5 years, while pressure is mounting from sponsors upon physicians to change patients to less expensive generic drugs. From 2008 and until 2016, several drugs (which were recording yearly U.S. sales of nearly $100 billion) are bound to go off-patent, which will bring about incremental sales to CVS.

In addition, I deem that Buffett was attracted by the fact that CVS exited the fiscal year of 2011 with cash as well as equivalents of $1.41 billion, in comparison with $1.42 billion by the end of the fiscal year 2010. The firm created over $4.6 billion in free cash for the year (which exceeded its own guidance of $4 to $4.2 billion). CVS is expecting to create a free cash flow of $4.6 to $4.9 billion during 2012 (as its own earlier guidance had been $4 to $4.2 billion) with the potential for further expansion beyond. A strong cash flow allows management to return value to stockholders. During the fourth quarter, the firm finalized its $2 billion share repurchase program linked to its 2010 authorization, for which it had left $450 million by the end of its third quarter. Thus, CVS managed to repurchase 12.6 million shares and, by the end of 2011, it could repurchase 83.7 million shares at nearly $35.85 per share, then spending nearly $3 billion. As a result, between dividends and share repurchasing actions, the firm returned over $3.5 billion to stockholders in all four quarters of the year 2011.

The current net profit margin of CVS is 3.23, which is lower than its 2010 margin of 3.55. I tend to avoid companies with lower profit margins than their previous ones, yet that in itself may constitute a reason to seek to analyze why that occurred. Its current return on equity is 9.14. It is lower than the 20% standard I look for in companies I invest in. It is also lower than its 2010 average return on equity of 9.33.

In terms of income and revenue growth, CVS has a 3-year average revenue growth of 6.98 and a 3-year net income average growth of 2.52. Its current revenue year over year growth is 11.82, higher than its 2010 revenue growth of -2.99. The fact that revenue could be increased in comparison to last year is a perfect example of a situation where business is performing well. The current net income year-over-year growth is 0.99, lower than its 2010 average of -7.28. I am not pleased when current net income growth is lower than in the past year. Most of the time, I look for companies that have managed to increase both their profits and revenue.

In terms of valuation ratios, CVS is trading at a Price/Book of 1.5x, a Price/Sales of 0.6x and a Price/Cash Flow of 10.4x in comparison to its industry averages of 1.8x Book, 0.4x Sales and 9.9x Cash Flow. It is essential to analyze the company's current valuation and check how it is trading in relation to its peer group.

As far as valuation is concerned, CVS's current trailing 12-month earnings multiple stands at 15.7x, in comparison to the industry average of 18.8x and 14.4x of S&P 500. I am attracted by the enhanced performance of the Pharmacy Services segment for a fourth consecutive quarter. Even though a number of concerns remain, on account of the margin pressure that is felt by the company, I am positive as regards CVS' longer-term potential, as based on its own deployment potential, retail execution as well as the solid generics cycle of 2012. Furthermore, I am pleased with the firm's important contracts, including the Medicare Part D business of the Universal American, the three-year FEP contract and the largest American public pension fund CalPers. Moreover, I reckon that the healthcare reform will bring about new opportunities for the firm. The company is endeavoring to profit from the ongoing Walgreen-Express Script dispute as regards its retail contract renewal: it thus anticipates a benefit of nearly $0.03 per share in first-quarter 2012 arising from such disagreement. Based on this, the company has raised its outlook for the fiscal year 2012, which is no less than encouraging.

Numerous fixed obligations of CVS are being taken off the balance sheet as operating losses. Nonetheless, I expect that CVS will generate a yearly multi-billion-dollar free cash flow. Consequently, I am not concerned about the company's financial health.

Source: 5 Top Growth Stocks Warren Buffett Owns