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 Advanced Battery Technologies (Nasdaq: ABAT ) -- he hasn't specifically mentioned anything about it to me -- we can discover whether it's the sort of stock that might interest him. Answering that question could also inform 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 Advanced Battery 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 Advanced Battery's earnings and free cash flow:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
While free cash flow has fluctuated somewhat, Advanced Battery's earnings have grown considerably over the past five 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 (5-year average)
|
|
Advanced Battery
|
0%
|
22%
|
32%
|
|
A123 Systems (Nasdaq: AONE )
|
42%
|
(45%)
|
(43%)
|
|
Ener1 (NYSE: HEV )
|
69%
|
(111%)
|
N/A*
|
|
China BAK Battery (Nasdaq: CBAK )
|
151%
|
(16%)
|
(3%)
|
Source: Capital IQ, a division of Standard & Poor's. *Not applicable because of negative equity.
Advanced Battery generates a fairly high return on equity without employing any debt.
3. Management
CEO Zhiguo Fu has been at the job since 2002. Prior to that, he worked in construction management for two decades. A short-selling blogger has alleged that the company is not on the up-and-up. Needless to say, Buffett would have to feel absolutely comfortable with management before investing in any company.
4. Business
The industry for rechargeable lithium-ion car batteries is in a development phase and fairly susceptible disruption. Though Buffett bought shares of hybrid car-maker BYD, it is a fairly unusual area for him.
The Foolish conclusion
Whether or not Buffett would buy shares of Advanced Battery, we've learned that while it may not operate in a technologically straightforward industry, it does exhibit some of the characteristics of a quintessential Buffett investment: consistent or growing earnings and high returns on equity with limited debt.
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