Warren Buffett tells us that the best protection against inflation is your own earning power, and the second best is a wonderful business. Here are three reasons why I think there might be a wonderful business underneath Rightmove (LSE: RMV) stock.
1. An economic moat
Rightmove is the UK’s largest online property platform and its size gives it what Buffett calls an economic moat. Specifically, Rightmove’s size means it benefits from a network effect.
A network effect happens when the value of a product or service increases as more people use it. In the case of Rightmove, having more buyers makes it a more attractive place for sellers to advertise and having more sellers makes it a more attractive place for buyers to search. This creates a barrier to entry for smaller competitors trying to take Rightmove’s market share.
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2. Low CAPEX
See’s Candies is one of Buffett’s favourite businesses because it produces lots of without needing much money to run. Whilst it’s great if a business produces a lot of cash, it’s less good if that cash needs to be reinvested to keep the business going. Rightmove’s free cash flow statement reveals that the money needed to maintain, grow, and upgrade its assets — the company’s capital expenditure (CAPEX) — is exceptionally low. Over the last 12 months, Rightmove generated just over £150 million in operating cash flow and spent just under £2 million in CAPEX. More generally, Rightmove’s CAPEX over the last five years has accounted for just 1.3% of the cash generated by its operations, leaving the rest available for growth, debt repayment, and shareholder returns.
3. Attractive shareholder returns
Rightmove’s management has used that free cash to reward shareholders. One of the reasons that Buffett loves Bank of America is the company’s use of buybacks, allowing shareholders to own a greater portion of the company without paying out for further investment. Rightmove’s modest debt has allowed management to steadily repurchase around 20% of its shares over the last decade. As a result, a 225% gain in net income generated by the business has translated to a 288% gain in earnings per share. During this time, Rightmove has also paid a regular and growing dividend to its shareholders, which currently yields around 1%.
Risks
Rightmove has a lot of the qualities of a wonderful business. But even a wonderful business carries risk from an investment perspective. The major risk to Rightmove stock that I can see comes from rising interest rates. This creates risk in two ways. First, rising interest rates make mortgages more expensive, which could slow the UK property market and inhibit the earnings of the underlying company. Second, rising interest rates increase the returns from savings and bonds, which might generate downward pressure on the stock, given that it currently trades at around 25 times sales and around 45 times earnings.
Overall, I think Rightmove has a lot of the characteristics that Warren Buffett looks for in a wonderful business. But one of the things that the Oracle of Omaha says about Kraft Heinz is that you can pay too much for a wonderful business. Since I think Rightmove stock is overpriced right now, especially with interest rates rising, I’ll be keeping it on my watchlist and waiting for a fair price.
