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 China Security & Surveillance (NYSE: CSR ) -- 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 China Security 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 China Security's earnings and free cash flow history:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
China Security's earnings have grown fairly substantially over the past five years. The free cash flow disparity is largely due to changes in working capital.
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)
|
| China Security & Surveillance |
77% |
13% |
21% |
| Checkpoint Systems (NYSE: CKP ) |
24% |
3% |
5% |
| OSI Systems (Nasdaq: OSIS ) |
1% |
9% |
2% |
| FLIR Systems (Nasdaq: FLIR ) |
0% |
17% |
24% |
Source: Capital IQ, a division of Standard & Poor's.
China Security generates a moderate return on equity while employing moderately high levels of debt.
3. Management
CEO Guoshen Tu has been at the job since 2005. Before taking the job, he worked in the security industry for several years.
4. Business
The type of security products China Security provides isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
Whether or not Buffett would buy shares of China Security, we've learned that the company exhibits some of the characteristics of a quintessential Buffett investment: consistent or growing earnings, tenured management, and a more-or-less straightforward industry, though he might watch to see whether the company can generate higher returns on equity.
If you'd like to stay up to speed on the top news and analysis on China Security or any other stock, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.
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