Racing Ahead: Return on Equity
Return on equity (ROE) is a metric that measures a company’s ability to generate profits. This is one factor Buffett uses when evaluating potential investments. The higher the ROE, the stronger the company’s core business. Ferrari, for example, demonstrates a strong ROE, as shown in the graph below. The luxury automaker not only has a renowned brand but also surpasses its rivals in various investing metrics.
Luxury Margins: Earnings Before Interest and Taxes (EBIT)
Another important factor Buffett considers is profit margins, specifically earnings before interest and taxes (EBIT). Higher-than-average margins and consistent growth indicate a competitive advantage. Ferrari sets itself apart in the automotive industry due to its brand image, racing heritage, and exclusivity. With vehicles starting in the hundreds of thousands of dollars, Ferrari maintains low global sales to ensure that demand consistently exceeds supply.
Unique “X” Factor
Ferrari’s unique attributes make it difficult for other automakers to replicate its success. The company’s brand image, racing heritage, and exclusivity give it a strong competitive edge. While many auto companies aim for mass production, Ferrari keeps its production volumes low, selling significantly fewer vehicles. In 2022, Ferrari set a new sales record by delivering just 13,221 vehicles, in stark contrast to mainstream brands selling millions annually.
Low-Risk Investment
While investment risk can take many forms, Ferrari mitigates it through two key factors. First, the company maintains a diverse shipment distribution across regions, minimizing its reliance on any specific market. Second, Ferrari targets an ultra-rich consumer segment, making it less vulnerable to adverse economic conditions. Comparatively, during challenging times, Ferrari’s revenue and EBIT decline less severely than other automotive companies like Ford Motor Company.
Why Doesn’t Buffett Own Ferrari?
Given Ferrari’s competitive advantages and resilience, one might wonder why Berkshire Hathaway doesn’t hold billions of dollars worth of its stock. The answer is simple: Ferrari rarely trades at a discount. With a price-to-earnings ratio of approximately 52, investing in Ferrari comes at a premium. While other automakers like Ford or General Motors often trade at lower single-digit price-to-earnings ratios, Ferrari rarely dips into value territory. It’s important to keep an eye on Ferrari in case it ever becomes more attractively priced. The company aligns with many of Buffett’s investment criteria and is likely to continue delivering long-term value to investors.