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Berkshire Coverage

Want to Be Like Buffett? These Stocks Can Help

Although these three firms might be too small for Berkshire, they have great competitive advantages, and our analysts think they're cheap, too.

It's a common refrain among stock investors that they want to be more like Warren Buffett. This shouldn't come as a huge surprise given Buffett's gleaming long-term record and folksy charm. But it is much easier said than done to follow Buffett's advice in buying companies with strong competitive advantages at a discount and holding them for extremely long periods of time. It takes strong nerves to fight the natural human urge to want to trade more frequently or buy into the latest craze.

So it might seem like a safe bet just to copy everything Buffett does. However, this doesn't buy a ticket to success. Buffett himself has said many times that he expects his investment returns going forward to pale in comparison with his past success. The sheer size of his portfolio means he isn't able to take advantage of smaller opportunities and must instead focus on mega deals such as buying Burlington Northern Santa Fe or Lubrizol. Investing or buying a small company just doesn't have a major impact on  Berkshire Hathaway's (BRK.A) (BRK.B) earnings power.

In many ways, individual investors dealing with much more modest sums are at an advantage. They can buy into small firms without worrying about moving the stock price. Last year, we ran a screen for some companies that fit Buffett's investing style but were much too small for him to consider. Of the firms that passed, we highlighted  MSCI (MSCI),  Avon Products , and  Zimmer Holdings (ZMH).

Frankly, these picks have not posted great performance during the last year, whereas the S&P 500 gained 5.35% during the same time frame. MSCI gained 3.85%, while Zimmer shed 2.00%, and Avon fell by more than 30.00%. The underperformance of MSCI and Zimmer could present a case study in the importance of Buffett's long-term horizon. Each of these companies faced some short-term headwinds, but our analysts still think their wide economic moats are intact and that the stocks still look somewhat undervalued. Investors that have the patience to hold on could still be richly rewarded.

Avon is another story. In the last year, the firm has faced huge disruptions to its core business and is deep in the midst of a strategic review. The firm's seeming inability to execute its strategy has led to our analyst to cut the moat rating on the company from wide to narrow, to raise the fair value uncertainty rating, and to lower the fair value estimate. In short, the fundamental investment case for the firm has changed, and it could be years before management turns around the business. This might not be a firm to load up on right now. Even Buffett isn't afraid to trade out of securities that have seen big changes to their investment thesis. Take for example the exit from his  Moody's (MCO) holdings as the business of traditional credit raters comes under increasing pressure.

As part of our coverage of the Berkshire Hathaway annual meeting this weekend, we thought we'd run a screen again using the  Premium Stock Screener. We searched for wide-moat firms that had Morningstar Ratings for stocks of 4 or 5 stars. We also required that these firms have been free cash flow positive for the last three years, produce returns on equity in excess of 10%, and have a market cap of less than $50 billion. Click here to  run the screen for yourself.

Below are three firms that passed the screen:

 Expeditors International of Washington (EXPD)
| Fair Value Uncertainty: Medium | Market Cap: $8.4 Billion
From the  Premium Analyst Report:
Expeditors International of Washington is the performance leader among non-asset-based freight-forwarding and third-party logistics providers. Investors seeking exposure to the growing international shipping market will be hard-pressed to find a more profitable, long-run-focused firm. Expeditors holds a mountain of cash, owes no debt, and produces strong cash flows while deploying nearly no assets. We believe Expeditors' record of steady growth, high margins, and high returns on invested capital supports a wide economic moat that will deliver the goods to shareholders for years to come. Expeditor's only unlovable trait is its normally rich valuation (P/E multiples often hover in the mid-30 times range). In our opinion, investors' interest should be piqued when the market is pricing in gloomy near-term demand.

 Western Union (WU)
| Fair Value Uncertainty: Medium | Market Cap: $10.8 Billion
From the  Premium Analyst Report:
Industry growth, market opportunities, and considerable competitive advantages position Western Union for long-term success. Western Union is the type of company we like best: a strong generator of free cash flow. The long-term reinvestment needs of its business are minimal. New agents cost little more than a Western Union sign to hang in the window, and the company's free cash flow, which has averaged about 20% of revenue during the past few years, should only increase over the long run.

 Applied Materials (AMAT)
| Fair Value Uncertainty: Medium | Market Cap: $14.6 Billion
From the  Premium Analyst Report
Applied Materials is the behemoth of the semiconductor equipment industry, with unmatched scale and a broad product portfolio. The firm steadily has been establishing its solar equipment business in an effort to drive growth. Although Applied was affected by cyclical slowdown in the semiconductor equipment market during the second half of 2011, the firm is now beginning to see a rebound in business conditions.

Data as of May 3. 

Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.