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PIcking Stocks like Bershire's Buffett

In Berkshire Hathaway's (nyse: BRK.A - news - people ) 2002 annual report, Warren E. Buffett and Charles T. Munger list several of their "acquisition criteria." Among them: more than $50 million in pretax earnings, consistent earnings power, good return on equity and low debt, good management and simple businesses. "If there's lots of technology," the two write, "we won't understand it."

Though you won't find it on Buffett and Munger's list of acquisition criteria, another item to keep an eye on is the enterprise multiple. Similar to but more complex than a price-to-earnings ratio, it is calculated by dividing enterprise value by operating income.

Enterprise value is a company's interest-bearing debt plus market value of stock, minus cash on hand. It represents the minimum amount a hypothetical acquirer would have to pay to make a deal. The denominator, "operating income," is defined here as earnings before interest, taxes, depreciation and amortization (EBITDA).

The enterprise multiple has an advantage over the plain old price-to-earnings ratio in that it gives a sense of a company's valuation relative to its entire capital structure, including debt. In our bargain hunting, we looked for enterprise multiples below industry averages.

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