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 Herbalife
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 Herbalife 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 Herbalife'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.
Over the past five years, Herbalife has generated consistent and growing earnings and free cash flow.
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) |
|---|---|---|---|
| Herbalife | 28% | 72% | 73% |
|
Church & Dwight |
12% | 15% | 17% |
|
Avon Products |
159% | 45% | 69% |
|
Nu Skin |
29% | 28% | 21% |
Source: Capital IQ, a division of Standard & Poor's.
Herbalife generates enormous returns on equity while employing fairly minimal debt by focusing on marketing rather than more capital-intensive activities.
3. Management
CEO Michael Johnson has been at the job since 2003. Prior to that, he worked for at Disney for almost two decades, where he ran Univision.
4. Business
Herbalife's products aren't particularly susceptible to technological disruption, though Buffett would likely be somewhat concerned with the risks inherent to potentially shifting consumer tastes in what is a developing industry.
The Foolish conclusion
Regardless of whether Buffett would ever buy Herbalife, we've learned that it exhibits several of the characteristics of a quintessential Buffett investment: consistent or growing earnings, and high returns on equity with limited debt, tenured management, and a technologically straightforward industry.
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