Buffett’s Acquisition Rules Applied Internationally by Christopher Gannatti, Associate Director of Research, The WisdomTree Blog
One of our most popular blog posts in 2015 focused on characterizing the types of companies that Warren Buffett and Berkshire Hathaway might see as interesting acquisitions targets. There was one criterion in particular that we found interesting:
“Businesses earning good returns on equity (ROE) while employing little or no debt.”1
In essence, this single line encapsulates the core focus of WisdomTree’s dividend growth strategies, which apply a focus on quality companies around the world.
Historically, the Chinese market has been relatively isolated from international investors, but much is changing there now, making China virtually impossible for the diversified investor to ignore. Earlier this year, CNBC pointed to signs that Chinese regulators may start easing up on their scrutiny of companies after months of clamping down on tech firms. That Read More
Exemplifying a “Quality Tilt”
When we say “quality” at WisdomTree, what we mean is a focus on the combination of:
- Three-year average return on equity (ROE) and
• Three-year average return on assest (ROA)
Focusing on both penalizes firms that may have high return on equity through the use of leverage or, in other words, debt.
Impact of Focusing on Quality: 3-Year Average Return on Equity (as of 5/31/2015 WisdomTree Index Screening)
For definitions of indexes in the chart, visit our glossary.
- 77.7% Weight in Stocks with Three-Year Average ROE above 16.1%: We arrived at this 16.1% three-year average return on equity figure as the boundary denoting the top 25% of three-year average return on equity values for the MSCI EAFE Index universe. WisdomTree’s methodology finds and then weights its securities such that nearly 80% of the Index’s weight is in these highly profitable firms.
- 80.5% Weight in stocks with Three-Year Average Return on Assets above 6.8%: While we don’t show it in the chart, this 6.8% figure is the three-year average return on assets figure that is the boundary for the top 25% in the MSCI EAFE Index universe. The idea of low leverage must connect these two figures.
- Comparing to the MSCI EAFE: The EAFE has approximately 30%–33% of its weight in the highest three-year average ROA and ROE quartiles, respectively, which sets the baseline for comparison. This means that WisdomTree’s International Dividend Growth Index is pushing more than twice the weight of the market capitalization benchmark into these respective top quartiles, a significant focus on quality.
Sector Manifestation of This Tilt
As a result of the global financial crisis of 2008–09, the word “leverage” found its way from the discussion of balance sheet statistics into more mainstream dialogue. As a result, the term became closely connected with Financials. Logically, an approach that focused on low leverage would necessarily have to under-weight Financials.
As of the May 31, 2015 Index Screening, the WisdomTree International Hedged Dividend Growth Index had an approximately 20% under-weight to Financials as measured against the MSCI EAFE Index. As bets against a benchmark go, we think the strength of this contrast duly emphasizes the commitment of WisdomTree’s dividend growth Index methodology to focus on quality companies.
Quality Stocks with a Currency Hedge to Reduce Risk
The WisdomTree Index that includes this quality tilt also employs a currency hedge on top of the equities to just target the local market return of these foreign equities. WisdomTree believes that currency hedging is becoming increasingly important as a strategic baseline for global allocations due to its risk reduction properties, as we discussed in this blog post. At a time when many investors are looking overseas for their additional portfolio allocations, the WisdomTree International Hedged Dividend Growth Index represents a marriage of two core ideas: a focus on quality companies positioned for growth, and the risk reduction properties of currency-hedged foreign allocations.
1Warren Buffett, “Letter to Shareholders 2015,” Berkshire Hathaway.
Important Risks Related to this Article
Dividends are not guaranteed, and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.