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 Sears (Nasdaq: SHLD ) – 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 a stock that should interest us.
In his 10-K filings, 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 Sears 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 Sears'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.
Sears has been a cash flow (if not earnings) machine until the last couple of years. Annual revenue has declined since the year ended 2007.
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 them in context:
Return on Equity (LTM)
Return on Equity
|Target (NYSE: TGT )||102%||19%||18%|
|Best Buy (NYSE: BBY )||23%||19%||23%|
|Home Depot (NYSE: HD )||52%||17%||17%|
Source: Capital IQ, a division of Standard & Poor's.
Compared to its peers, Sears generates low returns on equity with a moderate amount of debt.
CEO Louis D'Ambrosio has only been at the job since February, though he does have extensive experience with IBM.
Department store retail isn't particularly susceptible to technological disruption.
The Foolish conclusion
Whether or not Buffett would ever invest in Sears, we've learned that while the company operates in a straightforward industry, on its face the company doesn't particularly exhibit the characteristics of a quintessential Buffett investment: established management, stable earnings, and high returns on equity.
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