As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to track his investments and glean what they can from his thinking processes.
While we can't know for sure whether Buffett is about to buy SORL Auto Parts (Nasdaq: SORL ) -- to be fair, it's unlikely that he would actually invest in a Chinese small cap -- 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.
- Simple, non-techno mumbo jumbo businesses.
Does SORL meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on sure things. For that reason, he likes to see companies with demonstrated earnings stability. Let's examine SORL's earnings history:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
SORL is showing growing profits. That's a good sign.
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 Ratio
|
Return on Equity (LTM)
|
Return on Equity (5-year average)
|
| SORL |
7% |
17% |
20% |
| China Automotive (Nasdaq: CAAS ) |
70% |
29% |
19% |
| Wonder Automotive (Nasdaq: WATG ) |
62% |
18% |
14% |
Source: Capital IQ, a division of Standard & Poor's.
Over the last year, SORL has exhibited lower returns on equity than its peers. Over a five-year period, however, its returns on equity surpass theirs. SORL carries almost no debt.
3. Business
While no industry is completely immune to the ravages of time, the auto parts business isn't particularly prone to technological disruption. We're not talking astro-nanorobotics here.
The Foolish conclusion
Regardless of whether Buffett would ever buy SORL, we've learned that the company exhibits some of the characteristics of a quintessential Buffett investment: consistent earnings power, moderate debt levels, a simple business, and -- at least on a five-year time scale -- high returns on equity.
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