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.
While we can't know for sure whether Buffett is about to buy lululemon athletica
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 Lululemon 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 Lululemon's earnings and free cash flow:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
Over the past few years, Lululemon's net income and free cash flow have increased significantly.
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 among 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 |
|---|---|---|---|
| Lululemon | 0% | 39% | 33% |
|
Under Armour |
7% | 16% | 17% |
|
Nike |
7% | 22% | 22% |
|
bebe stores |
0% | 1% | 6% |
Source: Capital IQ, a division of Standard & Poor's.
Lululemon tends to generate extremely high returns on equity while employing no debt. The company's incredible profitability is one of the reasons I bought shares for the real-money Dada Portfolio I manage for The Motley Fool.
3. Management
Christine Day has been CEO since 2008. Prior to that, she had managerial experience at Starbucks and Select Comfort. Dennis Wilson has been chairman since he founded the company in 1998.
4. Business
Clothing is not particularly susceptible to technological disruption, but the yoga boom is likely too recent a development for Buffett to feel comfortable investing in it.
The Foolish conclusion
Regardless of whether Buffett would ever buy Lululemon, we've learned that the company exhibits some of the characteristics of a quintessential Buffett investment: growing or stable earnings, high returns on equity with limited debt, and tenured management.
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