I see The Home Depot Inc. (HD, Financial) is a new addition to the Buffett-Munger Screener, though I suspect it has been on the list before.
The screener has multiple criteria, so it is quite possible for a company to slide on and off the list. Those criteria reflect the important ideas that two of the most influential gurus use when they pick stocks.
According to GuruFocus, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) have four basic criteria for buying stocks.
First, it must be a simple business that they understand. Buffett was frequently criticized in the 1990s for not buying into the tech craze because he said he did not understand the businesses or their business models. Of course, he had his revenge during and after the tech collapse in 2000.
This criterion is not included in the screener model because it cannot be feasibly measured. Simplicity depends too much on the eye of the beholder and too little on data.
I believe Home Depot is a simple business for many of us as a lumber and hardware retailer, with a host of house-related products. If we were to look at its operations, though, we might expect complexity. No doubt it has algorithms galore that drive its logistics, pricing and more.
Second, a company should have predictable and proven earnings. Buffett will not buy on expectations; he only buys on results. A company must have a solid history of delivering returns before he or Munger will look at it.
GuruFocus has put it this way: “The key factor here is that the probability of investment loss is much smaller for predictable companies if the stocks are held for long period of time.”
That is an important distinction. Yes, it is nice to see your earnings go up every quarter or every year. After all, that is what ultimately drives the share price. However, not losing may be even more critical. As Buffett has memorably put it, “Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1.”
Again, Home Depot is up to the challenge. Over the past decade, it has grown its profits quite consistently. Few net income growth lines are as close to their trendline as this company’s. It has also risen by an average of 18.56% per year, which you do not have to be Buffett or Munger to appreciate.
Every year for the past 10 years, it has delivered a profit. This graphic representation of the income statement shows its how it arrived at net income in fiscal 2022:
Third, a company should have what Buffett calls an economic moat or competitive advantage. Those are protections from competitors that allow it to control its pricing. This control provides one of the mainstays of profitability and long-term viability; companies subject to commodity pricing can be driven out of business by lower-cost rivals.
Home Depot lists several competitive advantages in its 10-K for fiscal 2022. They include merchandising expertise, supply chain developments, customer fulfillment facilities, its premium real estate and its employees. To that list, I would add its brand name and its scale (which is captured in part by supply chain and fulfillment network).
If a company possesses enough competitive advantages, it should have industry-leading margins. Home Depot has them:
Fourth, the company should be available at a reasonable price. GuruFocus assesses Buffett-Munger valuations using the PEG ratio.
When the PEG ratio is less than 1, the stock is considered undervalued. Between 1 and 2, a stock should be thought of as fairly valued and anything over 2 will be overvalued.
Home Depot’s current PEG is 1.27, which places it closer to undervalued than overvalued. The ratio gets a boost from the company’s five-year average Ebitda growth rate of 14.10% per year.
For an alternative set of valuation metrics, GuruFocus added the GF Value Line. It builds on several historical multiples, including price-earnings, price-sales, price-book and price-to-free cash flow. To that, it adds an adjustment that reflects previous returns and growth, as well as forecasts of its business performance. This is the current GF Value chart:
The current share price is $299.31, while the GF Value is $367.27, so it concludes Home Depot is modestly undervalued. Put another way, the GF Value projects the company is undervalued by $67.96 and has a 22.70% margin of safety.
Conclusion
The Buffett-Munger Screener offers investors a quick and easy way to find quality companies that are available at a fair price. They may not garner as many headlines as tech stocks or pay big dividends, but they are solid companies that offer dependable results. They are simple to understand, have predictable earnings, have economic moats and are fairly priced. There is a lot to like in that short list of criteria.
