Priceline.com Inc (PCLN): Does It Pass Warren Buffett’s Test?

We’d all like to invest like the legendary Warren Buffett, turning thousands into millions or more. Buffett analyzes companies by calculating return on invested capital, or ROIC, to help determine whether a company has an economic moat — the ability to earn returns on its money above that money’s cost.

In this series, we examine several companies in a single industry to determine their ROIC. Let’s look at Priceline.com Inc (NASDAQ:PCLN) and three of its industry peers, to see how efficiently they use cash.

Of course, it’s not the only metric in value investing, but ROIC may be the most important one. By determining a company’s ROIC, you can see how well it’s using the cash you entrust to it and whether it’s actually creating value for you. Simply put, it divides a company’s operating profit by how much investment it took to get that profit. The formula is:

ROIC = net operating profit after taxes / Invested capital

(Get further detail on the nuances of the formula.)

This one-size-fits-all calculation cuts out many of the legal accounting tricks (such as excessive debt) that managers use to boost earnings numbers, and it provides you with an apples-to-apples way to evaluate businesses, even across industries. The higher the ROIC, the more efficiently the company uses capital.

Ultimately, we’re looking for companies that can invest their money at rates that are higher than the cost of capital, which for most businesses is between 8% and 12%. Ideally, we want to see ROIC above 12%, at a minimum, and a history of increasing returns, or at least steady returns, which indicate some durability to the company’s economic moat.

Here are the ROIC figures for Colgate and three industry peers over a few periods.

*Because PCLN did not report an effective tax rate for three years ago or five years ago, we used its 22% effective tax rate from last year.
**Because OWW did not report an effective tax rate for any of the years, we used a 22% effective tax rate.
Source: S&P Capital IQ. TTM=trailing 12 months.

Priceline.com Inc (NASDAQ:PCLN) has extremely high returns on invested capital that dwarf those offered by the other listed companies. It has also managed to consistently grow its returns over the past five years. Operating profit has skyrocketed while invested capital has been severely cut — the exact formula you want to see.