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 Sonic
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 Sonic 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 Sonic'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, Sonic has generated steadily declining earnings.
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 Ratio |
Return on Equity (LTM) |
Return on Equity (5-year average) |
|---|---|---|---|
|
Sonic |
1,457% |
47% |
N/A * |
|
Red Robin Gourmet Burgers |
47% |
4% |
9% |
|
BJ's Restaurants |
0% |
9% |
6% |
|
Jack in the Box |
82% |
13% |
21% |
Source: Capital IQ, a division of Standard & Poor's. *Negative equity 2006-2009.
Sonic's returns on equity aren't really that meaningful because its debt-to-equity ratio is so high.
3. Management
CEO Clifford Hudson has been at the job as far back as 1995. Prior to that, he'd held other jobs at Sonic.
4. Business
Restaurants aren't particularly susceptible to technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever buy Sonic, we've learned that while it has tenured management and operates in a straightforward industry, it doesn't particularly exhibit some of the quintessential characteristics of a Buffett investment: consistent earnings and high returns on equity with limited debt.
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