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 Activision Blizzard
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 Activision Blizzard 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 Activision Blizzard's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past few years, Activision's earnings and free cash flow have surged. (Their disparity is due in large part to the company's online subscription model.)
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 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 |
5-Year Average Return on Equity |
|---|---|---|---|
| Activision Blizzard | 0% | 7% | 16% |
|
Electronic Arts |
21% | (11%) | (14%) |
|
Take-Two Interactive |
20% | 0% | (5%) |
|
THQ |
136% | (114%) | (27%) |
Source: S&P Capital IQ.
Activision produces somewhat modest returns on equity, though they are higher than its unprofitable peers.
3. Management
CEO Robert Kotick has been at the job since 1991, an exceptionally long time.
4. Business
Gaming software requires constant research and development. While it isn't particularly prone to technical disruption -- we're not talking astro-bionanorobotics here -- Buffett tends to shy away from such tech-focused industries.
The Foolish conclusion
Regardless of whether Buffett would ever buy Activision, we've learned that, while returns on equity are somewhat modest, the company does exhibit some of the other characteristics of a quintessential Buffett investment: consistent or growing earnings, established management, limited debt, and superior returns on equity. To stay up to speed on Activision Blizzard's progress, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks by clicking here.
