Much has been written about US billionaire Warren Buffett. And there’s a good reason for that — he’s one of the richest people on the planet. And he got to that elevated position by investing well for decades. But would he buy Royal Mail (LSE: RMG) shares now?
It’s possible — with a little research — to have a good idea of the type of stock opportunities he searches for. And one of the best resources is his collection of annual letters to the shareholders of Berkshire Hathaway. That’s the company through which he executes most of his investments.
Buffett picks businesses, not stocks
I’d first note his recent comment that he doesn’t pick stocks, he picks businesses. And when he chooses one, he treats his shareholding as if he owns the company outright. In other words, he tends to hold on for the long term as value builds within the business when it grows. And he’s unlikely to sell just because the stock market is volatile.
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But to adopt a business-oriented mindset like that, Buffett tends to place emphasis on the quality of the enterprise. He’s looking for the best of the bunch. So quality indicators are important, such as returns against equity and profit margins. And he often speaks of businesses needing a competitive advantage to generate high returns. And to do that, they need what he describes as an economic moat to keep the competition at bay.
Sometimes moats come in the form of strong brands that customers love and keep returning for more. Sometimes it’s network effects or high customer switching costs. But there are others as well. And the important thing is to identify one. Those high financial return figures can help to alert us that an economic moat could be present in the operation.
Quality is not enough, though. I read a book called The Warren Buffett Stock Portfolio by Mary Buffett and David Clark, and they pointed out that Buffett often insists on a clear path to growth. He expects to hold an investment for years and he wants the business to expand its profits while he’s holding.
Valuation
Finally, Buffett is well known as an investor with a keen eye on price. Not only does he want quality and growth prospects, but he also insists on what he describes as a “fair” valuation when he buys the stock. So, he’s often out shopping for businesses when stock prices have fallen lower, perhaps because of worrying general economic news.
So how does Royal Mail (LSE:RMG) measure up against Buffett’s business-selection criteria? Not very well. The net profit margin runs somewhere below a modest 5% and the return against equity is about 12%. The return against invested capital is around just 8%. And I can’t identify a strong competitive advantage in the firm’s parcel business. Indeed, the company operates in a sector with lots of other companies offering similar services.
With the share price near 271p, the forward-looking price-to-earnings ratio is just below six for the trading year to March 2023. But Royal Mail has a fair amount of debt and a patchy earnings record. However, one positive point is the dividend yield. It’s predicted to be about 8% in the current trading year and that’s chunky. Nevertheless, my guess is that Royal Mail would be unlikely to attract Buffett.
