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 Baidu
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 Baidu 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 Baidu'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.
Earnings have grown dramatically for Baidu over the past several years.
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 |
|---|---|---|---|
| Baidu | 2% | 57% | 39% |
|
Yahoo! |
1% | 9% | 7% |
|
Google |
12% | 19% | 20% |
|
Sina |
2% | (2%) | 16% |
Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months.
Baidu generates an enormous return on equity while employing almost no debt.
3. Management
Robin Li co-founded Baidu and has been its CEO since 2004. Prior to founding the company, he was an engineer at search engine Infoseek and a consultant with IDD Information Services.
4. Business
Despite its wide moat, Internet search is a fairly new industry that can be susceptible to technological and market disruption -- remember Excite and Lycos?
The Foolish conclusion
Regardless of how reluctant Buffett might be to actually purchase Baidu because of its industry, we've learned that it does exhibit many of the other characteristics of a quintessential Buffett investment: consistent earnings, high returns on equity with limited debt, and tenured management.
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