Is MBIA a Buffett Idea?

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 MBIA (NYSE: MBI) -- he hasn't specifically mentioned anything about it to me -- he's left us some clues as to whether it's the sort of stock that might interest him. Answering that question could also inform whether it's an idea 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. Management in place.
4. Simple, non-techno mumbo jumbo businesses.

Does MBIA 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 MBIA'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.

MBIA hasn't consistently generated free cash flow and earnings; although this isn't unusual for the insurance industry, it's important for underwriting standards to be conservative.

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 put MBIA in context with other property and casualty insurers:

Source: Capital IQ, a division of Standard & Poor's.

MBIA has an extremely high debt-to-equity ratio for an insurer with negative returns on equity. This is due in large part to epic losses in its structured finance insurance business. MBIA is trying to recoup some of its claims by suing companies it claims misrepresented the value of the loans it guaranteed. Meanwhile, MBIA is being sued by JPMorgan (NYSE: JPM) and Citigroup (NYSE: C) for trying to transfer guarantees it may owe them into a new company. It's not an enviable position to be in.

3. Management
MBIA's CEO, Joseph Brown, has been at the job since 1999.

4. Business
Buffett is obviously no stranger to the insurance industry -- it's not one that's generally subject to major technological disruption.

The Foolish conclusion
Whether or not Buffett would ever invest in MBIA, we've learned that while it's in an industry Buffett favors and has a long-tenured CEO, doesn't exhibit the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt.