As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to glean what they can from his thinking processes and track his investments.
We can't know for sure whether Buffett is about to buy Netflix
In his most recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size, proven management, and a reasonable valuation, he demands:
- Consistent earnings power.
- Good returns on equity with limited or no debt.
- Management in place.
- Simple, non-techno-mumbo-jumbo businesses.
Does Netflix 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 Netflix's earnings:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
Netflix has grown its earnings rather substantially over the past five years as it's gradually displaced its bricks-and-mortar competitors.
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.
Since 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 |
Return on Equity (LTM) |
Return on Equity (5-Year Average) |
|---|---|---|---|
| Netflix | 70% | 84% | 32% |
|
Coinstar |
84% | 17% | 11% |
|
Time Warner |
51% | 8% | 3% |
|
Amazon.com |
0% | 15% | 38% |
Source: Capital IQ, a division of Standard & Poor's.
Netflix generates a high return on equity while employing moderate amounts of debt.
3. Management
CEO Reed Hastings has been at the job since 1998. He co-founded Netflix in 1997.
4. Business
Netflix has been an incredibly disruptive force in the video rental market, completely upending its high-fixed cost competitors. Now it's investing in digital delivery to ensure that it's not disrupted in turn.
The Foolish conclusion
Whether or not Buffett would buy shares of Netflix, we've learned that, while Buffett might be reluctant to invest in an expensive company whose industry is potentially subject to constant disruption, the company exhibits some of the characteristics of a quintessential Buffett investment: consistent or growing earnings, high returns on equity with limited debt, tenured management.
If you'd like to stay up to speed on the top news and analysis on Netflix or any other stock, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.
