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 Melco Crown
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 Melco 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 Melco’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, Melco has struggled to produce positive net income while it has invested heavily in its properties, particularly City of Dreams, which opened in 2009.
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) |
|---|---|---|---|
|
Melco Crown |
71% |
0% |
(6%) |
|
MGM |
414% |
(43%) |
(9%) |
|
Las Vegas Sands |
114% |
14% |
6% |
|
Wynn Resorts |
122% |
0% |
15% |
Source: Capital IQ, a division of Standard & Poor's.
Melco hasn’t generated a return on equity over the past five years. It employs a moderate amount of debt that is less than its peers’.
3. Management
Lawrence Ho has been managing director of Melco since 2001 and CEO since 2006. His father, Stanley Ho, is well-connected and one of the wealthiest businessmen in Asia, having held a monopoly in the Macau gambling industry for decades.
4. Business
The casino industry isn’t especially susceptible to technological disruption, though the Chinese government can change Macau’s gambling laws fairly readily, as it did when it placed restrictions on traveling to the area in 2009, probably to cool down the area’s legendary gambling industry.
The Foolish conclusion
Whether or not Buffett would buy shares of Melco, we’ve learned that, while it has tenured management and operates in a technologically straightforward industry, the company doesn’t exhibit the other quintessential characteristics of a Buffett investment: consistent earnings and high returns on equity with limited debt.
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