In the world of long-term investors, Warren Buffett stands out as one of the best. The Berkshire Hathaway CEO’s ability to identify great opportunities has been outstanding over time.
Buffett looks for several things in companies to invest in. But one of the most important things is how efficiently a business generates cash – and this is something investors can assess themselves.
Returns on equity
From an investment perspective, a business isn’t just about how much profit it makes. An important part of the equation is how much the company has to invest to generate that cash.
One metric to look at is return on equity, which measures a firm’s profits as a percentage of the difference between its assets and its liabilities. But Buffett’s approach is more nuanced than this.
A high return on equity is a positive sign. But Buffett’s view on this has changed over time to focus more specifically on returns on tangible assets over intangible ones.
Tangible assets are things like equipment, manufacturing facilities, and inventory. Intangible assets are things like technical knowledge, intellectual property, and brands.
The biggest difference is that tangible assets need maintaining and replacing over time. As such, they represent potential future costs for the business.
This isn’t the case with intangible assets, which is why Buffett has moved towards companies that generate strong returns on tangible assets specifically. And the difference can be quite striking.
Coca-Cola Europacific Partners
A good illustration of this is Coca-Cola Europacific Partners (LSE:CCEP). The firm produces and distributes Coca-Cola products across Western Europe as well as in Australia and New Zealand.
Officially, the company’s operating income in 2024 was €2.13bn and the firm had €31.3bn in assets. That doesn’t look like a terrific return, but a closer look reveals a different picture.
At the end of 2024, CCEP had €12.1bn in what it calls “indefinite lived intangible assets”. These are essentially the firm’s agreements with the Coca-Cola company (in which Berkshire Hathaway has a huge investment).
CCEP doesn’t have to invest in these in the way it has to maintain its manufacturing facilities. So there’s a case for subtracting these from the firm’s equity base for a more Buffett-like calculation.
This brings the asset base down to around €20bn and takes the return from around 6.8% to 10.7%. And that makes the equation much more attractive for investors.
There’s a lot more to CCEP than this. The strength of the firm’s brands and the risk of GLP-1 drugs weighing on demand are also important considerations for long-term investors to think about.
Finding stocks to buy
Warren Buffett’s investment in Coca-Cola is well-known. The stock has generated terrific returns for Berkshire Hathaway over the last 35 years.
Berkshire doesn’t own shares in the European bottling franchise. But I think the company provides a great illustration of how the Oracle of Omaha thinks about returns on equity.
The firm is more attractive in this regard than it looks at first sight. Valuable intangible assets make returns on equity seem lower than they might otherwise.
The stock is a newcomer to the FTSE 100 and I think there are better opportunities available at the moment. But strong returns on tangible assets identify it as a quality company and one to watch.
