Does Las Vegas Sands Pass Buffett's Test?

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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, in order 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 take a look at several companies in a single industry to determine their ROIC. Let's take a look at Las Vegas Sands (NYS: LVS) 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

The nuances of the formula are explained in further detail here. 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 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 four industry peers over a few periods.

Company

TTM

1 Year Ago

3 Years Ago

5 Years Ago

Las Vegas Sands13.2%7.0%1.4%*8.5%
MGM Resorts1.8%**1.4%**3.0%**6.4%
Wynn Resorts18.6%***13.5%5.5%***2.1%
Melco Crown Entertainment6.4%****1.5%****0%****(2.1%)****

Source: S&P Capital IQ. TTM = trailing 12 months.
*Because Las Vegas Sands did not report an effective tax rate, we used its 12.3% rate from 5 years ago.
**Because MGM did not report an effective tax rate, we used its 25% rate from 3 years ago.
***Because Wynn did not report an effective tax rate, we used its 21.3% rate from 5 years ago.
****Because Melco did not report an effective tax rate, we used a 35% rate.

Las Vegas Sands' returns on invested capital declined significantly three years ago, but they were up again in the last 12 months. MGM Resorts (NYS: MGM) saw steady declines in its ROIC between five years ago and one year ago, but has begun to show a slight upward trend in the last four quarters. Wynn Resorts (NAS: WYNN) has seen steady increases in its ROIC since five years ago, making it the best-run of the large casino companies. Finally, Melco Crown Entertainment (NAS: MPEL) shows slower but nevertheless steady growth in its ROIC, which we like to see.

Las Vegas Sands (NYS: LVS) , Wynn, and Melco have gained some success from their presence in the Asian market -- especially in Macau. However, all of these companies have hurdles to cross in order to promote future growth.  For example, further growth in the casino market is prohibited in Singapore until 2017, and so these companies will have to find other areas in which to expand, though Las Vegas Sands already has a casino there. Also, economic growth is struggling in some of the Asian markets they are targeting.

MGM Resorts has some presence in Asia -- particularly in popular gaming city Macau. However, most of MGM's business resides in Las Vegas, where gaming has been hit very hard. MGM also has a debt pile close to double its annual revenue, which puts MGM in a difficult position even if the gaming business in Las Vegas recovers. However, if online poker becomes legal in the U.S., MGM stands to profit from a joint venture with Boyd Gaming (NYS: BYD) , which struck a deal with bwin.party. The deal gives the company access to power brand PartyPoker.

Businesses with consistently high ROIC show that they're efficiently using capital. They also have the ability to treat shareholders well, because they can then use their extra cash to pay out dividends to us, buy back shares, or further invest in their franchise. And healthy and growing dividends are something that Warren Buffett has long loved.

So for more successful investments, dig a little deeper than the earnings headlines to find the company's ROIC. If you'd like to add these companies to your Watchlist, click below:

At the time this article was published Jim Royal, Ph.D., does not own shares of any company mentioned here.Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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