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 Baidu (Nasdaq: BIDU ) (he hasn't specifically mentioned 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 a 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: S&P Capital IQ.
Over the past five years, Baidu's earnings and free cash flow have grown dramatically.
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 among peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context.
Baidu generates an enormous return on equity -- 54% over the past year and 45% on average over the past five years -- while employing a modest 16% debt-to-equity ratio.
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.
Despite its wide moat, Internet search is a fairly new industry that could be susceptible to technological and market disruption -- remember Excite and Lycos?
The Foolish conclusion
So is Baidu a Buffett stock? It's a mixed picture. The company easily exhibits many of the quintessential characteristics of a Buffett investment: consistent or growing earnings, high returns on equity with limited debt, and tenured management. But despite Buffett's and his right-hand man Munger's admiration for the competitive strengths of the search industry, they would be hesitant to invest in such a constantly evolving tech industry. But that fact alone doesn't necessarily make it a bad stock.
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