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 Zagg (Nasdaq: ZAGG ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal whether it's a stock that should interest us.
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 Zagg 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 Zagg‘ 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.
Over at least the past five years, Zagg's earnings have increased dramatically with consumers' widespread adoption of its accessories. Free cash flow has been negative because of major changes in working capital, especially big inventory increases.
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)
|
| Zagg |
11% |
47% |
(3%) |
| Mad Catz Interactive (AMEX: MCZ ) |
51% |
46% |
(1%) |
| Universal Electronics (Nasdaq: UEIC ) |
9% |
8% |
10% |
| Harman International Industries (NYSE: HAR ) |
28% |
11% |
4% |
Source: Capital IQ, a division of Standard & Poor's.
Since 2008 -- the fourth quarter of which iPhone sales really began to take off -- Zagg has generated very high returns on equity while employing little debt.
3. Management
CEO Bob Pedersen has been at the job since 2006. Before that, he worked in management, sales, and communications for different startups.
4. Business
Zagg's products, such as the invisibleSHIELD coatings for iPhone screens, could be somewhat vulnerable to technological disruption should another company develop a better mousetrap, though the company isn't especially susceptible in the grand scheme of tech products. There's also the risk of missing new technology trends.
The Foolish conclusion
Regardless of whether Buffett would ever buy Zagg, we've learned that, although the company's future is a bit tied to the rapidly (and, Buffett might think, unpredictable) changing market for consumer technology products, it does exhibit some of the characteristics of a quintessential Buffett investment: consistent or growing earnings, high returns on equity with limited debt, and tenured management -- although it is worth noting that various research shops, such as Citron Research, have published articles critical of the credibility of Zagg's management. You can see Citron's Research and decide for yourself, but any lack of management ethics is a serious lapse for Buffett and would probably prohibit his investment in the company.
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