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 MGM Resorts (NYSE: MGM ) -- 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 MGM 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 MGM's earnings and free cash flow history:
Source: S&P Capital IQ.
Like many casino operators, MGM's earnings were hit pretty hard during the economic downturn but have since begun to recover. The huge net income gain in the past twelve months was a one-time gain related to its acquisition of MGM China. The surge in free cash flow beginning in 2008 was largely related to cutting back on capital 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-to-equity ratio, 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.
Return on Equity
5-Year Average Return on Equity
|Las Vegas Sands||100%||21%||5%|
Source: S&P Capital IQ.
Returns on equity are all over the map in the gaming industry. MGM's, in particular, have been incredibly volatile, as have Melco Crown's, which underwent a major expansion with its City of Dreams project a couple of years back. Wynn appears to easily take the cake as far as returns on equity are concerned, with Sands turning in respectable results, too.
CEO James Murren has been at the job since 2008. Prior to that, he'd been a stock analyst on Wall Street before working as MGM's CFO for about a decade.
The games might change a little, but the casino business isn't particularly susceptible to technological disruption.
The Foolish conclusion
So, is MGM a Buffett stock? Probably not. While the company operates in a straightforward industry and has tenured management, it doesn't particularly exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt. However, if you're interested in a stock that our top analysts and chief investment officer picked to beat the market, you can check out The Motley Fool's top stock for 2012. It details a company revolutionizing commerce in Latin America. I invite you to download this special report for a limited time by clicking here -- it's free.