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 DryShips (Nasdaq: DRYS ) -- 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 tell us 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:
1. Consistent earnings power.
2. Good returns on equity with limited or no debt.
3. Quality of management.
4. Simple, non-techno-mumbo-jumbo businesses.
Does DryShips 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 DryShips' 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. LTM = Last 12 months.
Source: Capital IQ, a division of Standard & Poor's. Free is adjusted based on author's calculations. LTM = Last 12 months.
Over at least the past five years, DryShips' profits have been volatile and frequently negative.
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 considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will 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)
|
|
DryShips
|
103%
|
2%
|
9%
|
|
Eagle Bulk Shipping (Nasdaq: EGLE )
|
172%
|
3%
|
6%
|
|
Excel Maritime (NYSE: EXM )
|
74%
|
20%
|
17%
|
|
Diana Shipping (NYSE: DSX )
|
29%
|
12%
|
23%
|
Source: Capital IQ, a division of Standard & Poor's.
DryShips exhibits a low return on equity while employing considerable amounts of debt -- not exactly a hallmark of a strong competitive advantage.
3. Management
DryShips' Chairman and CEO, George Economou, has been at the job since the company's founding in 2004. Before that, he had worked in the shipping industry for decades.
4. Business
The shipping business is fairly predictable technologically, though it is very competitive.
The Foolish conclusion
Regardless of whether DryShips is a good buy or not, we've learned that it probably doesn't exhibit two characteristics of a quintessential Buffett investment: consistent earnings power and strong signs of a competitive advantage.
Ilan Moscovitz doesn't own shares of any company mentioned. The Fool has a disclosure policy.
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