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The Oracle of Omaha Warren Buffett is generally viewed as the most respected and successful investor in history, and many of our value-oriented readers follow the movements and purchases of Buffett rather closely and for good reason. Berkshire Hathaway, a conglomerate holding company, which Buffett built from a textile company into a major corporation, has averaged a 20.3% compounded annual gain in per-share book value from 1965-2008. There is no doubt about the success Buffett has achieved over the years, and there has even been a recent study done that shows an investor could have earned over 14% returns a year had they purchased each Buffett stock, a month after his investment company disclosed ownership.

We thought it would be an interesting story to show how Buffett’s holdings would rank according to The Applied Finance Group’s (AFG’s) valuation model and Economic Margin Methodology. The companies we believe look the most attractive and that investors should pay the most attention to when searching for long investment opportunities are the companies that have both an attractive default AFG valuation and are expected to improve their Economic Margins at a greater rate than their sector peers.

AFG's track record of identifying winners and losers has proven that companies AFG identifies as undervalued are more likely to outperform, than those AFG ranks as overvalued, and the same holds true for companies with expected improvements in EMs vs. expected declines. The Economic Margin methodology adjusts for common distortions in GAAP accounting practices and helps investors to understand the true economic profitability a company earns above its cost of capital. By understanding the true economic profitability a company earns and by gaining a firm grasp on the expectations embedded in security prices, investors can come to a more refined intrinsic value for a company and thus put themselves in a better position to outperform.

Below is a list of Berkshire Hathaway’s current holdings (excluding Financials) ranked by valuation attractiveness, and followed by expected change in economic margins.

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Keeping an eye on the big movers in the market does not help investors determine which stocks are poised to continue their upward or downward movement. To help our devoted readers identify the movers that still look fundamentally sound and those to walk away from, ValueExpectations.com has scored each of the top 10 Hot and Cold stocks of the month based on Valuation Attractiveness and Economic Margin Change.

If an investor should consider adding any of these stocks as a holding for a portfolio, one should look for companies with attractive valuations and expected improvements in a company’s Economic Margin (EM) which essentially is a measure of a company’s true economic profitability. As an additional level of analysis, we also recommend understanding the embedded expectations that are priced into each of these stocks.

AFG’s Valuation techniques and understanding of economic profitability have proven to identify mispriced securities in the market and help clients take advantage of mispriced securities. Accurately assessing a company’s profitability and understanding how to answer key questions such as… What is the cash flow generated by the company’s operations? How much capital is required? What are the opportunity costs of this capital? This robust process is what sets AFG’s corporate performance metric Economic Margin (EM) apart from other Value Based Metrics such as an IRR calculation, a CFIRR or a RONA Economic Profit approach.

It is not surprising to see the list of best performers dominated by Tech stocks as professional investors in our last month’s sentiment poll identified Technology as the most attractive sector to bet on in the upcoming months and companies like DOW and EK on their respective best and worst lists as they both have been discussed recently on VE.com. Dow was recently noted as one of the most attractive stocks within AFG’s Basic Materials sector (ranked 2nd most attractive sector amongst professional investors) in mid-august. Eastman Kodak (EK) is just one example of a torpedo AFG’s clients and ValueExpectations.com readers have avoided due to regularly being on AFG lists of stocks to avoid and also a model of poor Earnings Quality (high accruals) one way AFG filters out companies likely to underperform, and more likely to encounter a negative earnings surprise. EK has consistently had a poor EQ score according to AFG’s measure of accruals and continues to be ranked amongst the worst in its sector in Earnings Quality.

In yesterdays article we provided an update of the performance of our annual HOT STOCK LIST:

We also provided an update of the performance of the Toreador Large Cap Fund, TORLX which uses AFG’s Economic Margin Framework as part of its investment philosophy.

As you may note, both have done very well!

Today we decided to provide a Buy/Sell list to VE’s registered visitors applying some of these same investment principles: Economic Margin, Management Quality, and a company's Percent to Target (the deviation between a stock's current trading price and its current default target price according to AFG).

Below is a preview of the list which includes a Buy/Sell Recommendation on each Stock. The complete list, accessible to Value Expectations registered users, contains around 500 Stocks.

Source: The Applied FInance Group

To download the complete list click here.

With Berkshire Hathaway’s annual meeting just behind us, we thought it would be interesting to provide an analysis of the Oracle of Omaha’s companies (ex. Financials) to give you a better idea of their valuation attractiveness. The companies that rank highest on valuation should be more likely to outperform going forward and could represent an attractive investment opportunity.

Year to date Mr. Buffet’s portfolio has delivered an average return of 5.18% compared to the 12.93% delivered by the S&P 500 Index (as of May 8, 2009). In the future we will measure the performance of each of the three groups of stocks we now label as Attractive, Fairly Valued, and Unattractive, in order to see what type of spreads are achieved between them.

Berkshire Hathaway's Holdings (ex. Financials) Ranked By Valuation Attractiveness

If you want to learn more about AFG's Valuation methodology, click here.