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 Amazon (Nasdaq: AMZN ) -- 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 this series, we do just that.
Writing 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 Amazon 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 Amazon's earnings and free cash flow history:
Source: S&P Capital IQ.
For the most part, Amazon's earnings have grown fairly steadily over the past five years, though they've dipped over the past year as the company has ramped up its operating expenditures.
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 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 Ratio
|
Return on Equity
|
5-Year Average Return on Equity
|
| Amazon |
0% |
12% |
38% |
| Google (Nasdaq: GOOG ) |
13% |
20% |
20% |
| eBay (Nasdaq: EBAY ) |
16% |
12% |
12% |
| Overstock (Nasdaq: OSTK ) |
234% |
(8%) |
(28%) |
Source: S&P Capital IQ.
With the exception of the past year, Amazon has tended to generate enormous returns on equity while employing no debt.
3. Management
Jeff Bezos become CEO in 1996, two years after he founded the company.
4. Business
Amazon is building a strong brand and technology platform, but Internet retail could still be quite susceptible to technological and market disruptions.
The Foolish conclusion
So is Amazon a Buffett stock? Probably not, given its industry. But it's interesting to discover that the company does exhibit many of the other quintessential characteristics of a Buffett investment: consistent or growing earnings, high returns on equity with limited or no debt, and tenured management. To stay up to speed on Amazon's progress, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks by clicking here.
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