Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, thousands try to glean what they can from his thinking processes and track his investments.
While we can't know for sure whether Buffett is about to buy Penn National Gaming (Nasdaq: PENN ) – he hasn't specifically mentioned anything about it to me -- he's left us some clues as to whether it's the sort of stock that might interest him. Answering that question could also inform whether it's a stock that should interest us.
In his 10-K filings, Buffett lays out the qualities he looks for in an investment. In addition to adequate size 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 Penn 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 Penn'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.
Penn's earnings and free cash flow are fairly volatile, particularly due to a number of writedowns for a variety of reasons.
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 put them in context:
|
Company
|
Debt-to-Equity Ratio
|
Return on Equity (LTM)
|
Return on Equity
(5-Year Average)
|
| Penn National Gaming |
124%
|
(3%)
|
4%
|
| International Game Technology (NYSE: IGT ) |
120%
|
18%
|
23%
|
| Boyd Gaming (NYSE: BYD ) |
247%
|
1%
|
2%
|
| Pinnacle Entertainment (NYSE: PNK ) |
232%
|
(8%)
|
(7%)
|
Source: Capital IQ, a division of Standard & Poor's.
Penn generates low returns on equity with a fair bit of debt.
3. Management
CEO Peter Carlino has been at the job since 1994.
4. Business
Gaming isn't particularly susceptible to technological disruption.
The Foolish conclusion
Whether or not Buffett would ever invest in Penn, we've learned that it exhibits some of the characteristics of a quintessential Buffett investment: established management and a straightforward business, but it doesn't generate high stable earnings or returns on equity with limited debt.
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