Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, thousands try to glean what they can from his thinking processes and track his investments.
While we can't know for sure whether Buffett is about to buy Ford (NYSE: F ) -- he hasn't specifically mentioned anything about it to me -- we can discover whether it's the sort of stock that might interest him. Answering that question could also inform whether it's a stock that should interest us.
In his most recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size and a reasonable valuation, he demands:
- Consistent earnings power.
- Good returns on equity with limited or no debt.
- Management in place.
- Simple, non-techno-mumbo-jumbo businesses.
Does Ford meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine Ford's earnings and free cash flow history:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
Source: Capital IQ, a division of Standard & Poor's. Free is adjusted based on author's calculations.
Over at least the past five years, Ford's profits have been volatile, though things appear to be somewhat on the mend.
2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When gauging return on equity, it's important to make sure a company doesn't have an enormous debt burden. That could skew your calculations and make the company look much more efficient than it actually is.
Since competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context:
|
Company
|
Debt-to-Equity Ratio
|
Return on Equity (LTM)
|
Return on Equity (5-year average)
|
|
Ford
|
N/A
|
N/A
|
N/A
|
|
Toyota (NYSE: TM )
|
121%
|
5%
|
8%
|
|
Honda (NYSE: HMC )
|
94%
|
13%
|
11%
|
|
Harley Davidson (NYSE: HOG )
|
306%
|
5%
|
27%
|
Source: Capital IQ, a division of Standard & Poor's.
Unlike its peers, Ford has negative (but rising!) equity, so it doesn't have a return on equity. The company employs fairly considerable debt.
3. Management
Ford's CEO, Alan Mulally, has only been at the job since 2006. Prior to that, he had worked in the aerospace industry. That's not to say he won't continue leading a successful turnaround, but turnarounds aren't ordinarily Buffett's cup of tea.
4. Business
The auto industry involves considerable technological innovation, though it's not as unpredictable as, say, the start-up biotech industry.
The Foolish conclusion
Whether Ford is a good buy or not, we've learned that it probably doesn't exhibit the characteristics of a quintessential Buffett investment: consistent earnings power, high returns on equity, and minimal debt.
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