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Is eBay a Buffett stock?

Sunday - 4/22/2012, 3:00pm  ET

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 eBay -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal whether it's a stock that should interest us. In this series, we do just that.

Writing in a 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:

  1. Consistent earnings power.
  2. Good returns on equity with limited or no debt.
  3. Management in place.
  4. Simple, non-techno-mumbo-jumbo businesses.

Does eBay 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 eBay's earnings and free cash flow history:

Source: S&P Capital IQ.

Over the past several years, eBay's earnings and free cash flow have been consistent. (The earnings spike in 2011 came from an asset sale.)

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.

eBay generates moderate returns on equity -- 19% over the past year, 14% on average over the past five years -- while employing a modest 11% debt-to-equity ratio.

3. Management
CEO John Donahoe has been at the job since 2008. Before that, he helped run the company's auction business and spent several years at Bain Capital.

4. Business
Buffett would be wary of a company as reliant on the rapidly developing e-commerce space as eBay, though he might be impressed by PayPal's potential and the competitive advantage of eBay's network effect (i.e., buyers go to eBay because that's where all the sellers are, and vice versa).

The Foolish conclusion
So is eBay a Buffett stock? Probably not. Although the company does exhibit some of the quintessential characteristics of a Buffett investment -- consistent earnings and tenured management -- it doesn't particularly exhibit others: high returns on equity and a technologically straightforward business. However, you can stay up to speed on eBay's progress by adding it to your stock Watchlist.

And if you'd like to find out about one fast-growing retail stock -- a company that's changing the face of commerce in Latin America -- check out "The Motley Fool's Top Stock for 2012."

This article was originally published as Is eBay a Buffett Stock?on Fool.com

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