What is the Buffettology: Sustainable Growth Screen?
The Buffettology: Sustainable Growth Screen applies Warren Buffett's investing method through a single engine: the rate at which a company can compound its own book value. It is drawn from Buffettology (1997), written by Mary Buffett and David Clark, who laid out the "previously unexplained techniques" behind Buffett's record at Berkshire Hathaway. The American Association of Individual Investors built the screen in Stock Investor Pro. Where a plain earnings screen asks how fast profits grew, this one asks a deeper question — how fast the business can grow them from the inside, using nothing but retained profit reinvested at a high return.
The core idea: the sustainable growth rate
A company that keeps most of its earnings and reinvests them at a high return on equity grows its equity base without issuing stock or leaning on debt. That internal engine has a name and a formula: the sustainable growth rate equals return on equity multiplied by the retention ratio, where the retention ratio is one minus the dividend payout ratio. A firm earning 22% on equity that pays out little can expand book value at close to 20% a year on its own. Buffett prizes exactly this pairing — high ROE, low payout, reinvestment that keeps clearing a high bar — because compounding book value is what eventually pulls the share price up behind it.
The screen stacks quality filters that a genuine compounder should pass. Return on equity, both current and averaged over seven years, must exceed 12%. Operating and net margins have to beat the industry median, the mark of pricing power rather than a race to the bottom. Seven-year EPS growth must rank in the database's top quartile with the three-year rate keeping pace, and earnings must have stayed positive every year — erratic profits are the signature of the commodity businesses Buffett avoids. Debt is capped below the industry median, since a firm that compounds internally has little need to borrow.
What the screen looks for
- Operating margin at least as high as the industry median.
- Net profit margin at least as high as the industry median.
- Total liabilities as a share of total assets (latest quarter) no higher than the industry median for that period.
- Seven-year EPS growth from continuing operations in the database's top 25% — a percentile rank of 75 or better.
- Three-year EPS growth no slower than the seven-year rate.
- EPS from continuing operations positive for the trailing 12 months and each of the past seven years.
- Current return on equity over 12%.
- Seven-year average return on equity over 12%.
- Projected EPS growth of at least 15% under the sustainable growth model.
- Over-the-counter (OTC) stocks excluded.
The valuation math: compounding book value forward
The final filter turns the sustainable growth rate into a ten-year forecast. Take current book value per share and grow it at that rate for a decade. Multiply the year-ten book value by the average return on equity to get year-ten earnings per share, apply the stock's average price-earnings ratio to reach a projected price, and add the dividends paid over the period. The annualized gain against today's price must clear 15%.
The book's example runs the chain end to end. A 22.8% average ROE and a 15.9% payout ratio give a sustainable growth rate of 19.2%. Book value of $11.38 per share, compounded at 19.2% for ten years, grows to about $65.90. Multiply by the 22.8% ROE and year-ten earnings come to $15.03 a share; at an average P/E of 14.0 the projected price is $210.42, and adding $12.71 of dividends lifts the ten-year return to 16.5% a year against a $48.25 price. The whole result hinges on ROE staying near 22.8% for a decade — a demanding assumption the quality filters exist to defend.
Buffett cross-checks this with a second lens: the initial rate of return. He reads a stock's earnings yield — earnings per share divided by price — as the coupon on a "bond" with a growing payout, and compares it to the long-term government bond yield. A stock whose earnings yield sits near the bond yield looks fair, with the difference that a consumer monopoly's earnings should rise over time while the bond's coupon never moves.
What to keep in mind
Sustainable-growth math is elegant and unforgiving of its inputs. A one-point change in the assumed ROE swings the ten-year price meaningfully, and reported ROE can flatter a company for the wrong reasons — heavy buybacks shrink equity and lift the ratio, while goodwill and write-offs distort book value until it barely reflects the business. The model also assumes the firm keeps finding high-return places to park retained earnings; many mature monopolies eventually cannot, and the excess cash sits idle or chases weaker projects. Confirm that the return on equity is earned, not engineered, before you trust the projection.
Sources
Buffettology: The Previously Unexplained Techniques That Have Made Warren Buffett the World's Most Famous Investor, Mary Buffett and David Clark, Simon & Schuster, 1997.
American Association of Individual Investors (AAII) — Stock Investor Pro screen definition and commentary.