Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, thousands try to glean what they can from his thinking processes and track his investments.
While we can't know for sure whether Buffett is about to buy SanDisk (Nasdaq: SNDK ) -- he hasn't specifically mentioned anything about it to me -- he's left us some clues as to whether it's the sort of stock that might interest him. Answering that question could also tell us whether it's an idea that should interest us.
In his most recent 10-K filed with the SEC, Buffett lays out the qualities he looks for in an investment. In addition to adequate size and a reasonable valuation, he demands:
1. Consistent earnings power.
2. Good returns on equity with limited or no debt.
3. Quality management.
4. Simple, non-techno mumbo-jumbo businesses.
Does SanDisk meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine SanDisk's earnings and free cash flow history:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations. LTM = last 12 months.
Source: Capital IQ, a division of Standard & Poor's. Free is adjusted based on author's calculations. LTM = last 12 months.
With the exception of SanDisk's losses in 2008, which were the result of a temporary sales plunge amid a spike in research and development costs and selling, general, and administrative expenses, SanDisk has been profitable since 2002.
2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will skew your calculations and make the company look much more efficient than it actually is.
Because competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context:
|
Company
|
Debt-to-Equity Ratio
|
Return on Equity (LTM)
|
Return on Equity (5-Year Average)
|
|
SanDisk
|
21%
|
27%
|
(2%)
|
|
Micron (Nasdaq: MU )
|
31%
|
24%
|
(10%)
|
|
Imation (NYSE: IMN )
|
0%
|
(1%)
|
1%
|
|
Intel (Nasdaq: INTC )
|
5%
|
22%
|
16%
|
Source: Capital IQ, a division of Standard & Poor's.
SanDisk has a historic low-to-moderate return on equity that has spiked along with booming demand and supply shortages over the past year. Overall, this makes sense for a commodity business like NAND-flash production.
3. Management
Eli Harari has been SanDisk's CEO since he founded the company in 1988. Soon he will step down and fellow co-founder Sanjay Mehrotra will take over.
4. Business
Buffett largely shies away from industries like SanDisk's that require constant technological innovation to stay relevant.
The Foolish conclusion
Whether or not Buffett would ever invest in SanDisk, we've learned that while Buffett would likely be impressed with all that Mr. Harari has done during his long tenure, SanDisk operates in a high-tech industry with fairly low moats and returns on equity.
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