As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to glean what they can from his thinking processes and track his investments.
We can't know for sure whether Buffett is about to buy American Axle & Manufacturing (NYSE: AXL ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal 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, proven management, 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 American Axle & Manufacturing 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 American Axle & Manufacturing's earnings and free cash flow history:
Earnings have been a bit volatile for American Axle & Manufacturing over the past five years, though much of the big loss in 2008 was due to restructuring charges that compounded that year's operating losses.
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
|
Return on Equity (LTM)
|
Return on Equity (5-Year Average)
|
| American Axle & Manufacturing |
N/A* |
N/A* |
N/A* |
| BorgWarner (NYSE: BWA ) |
58% |
23% |
9% |
| TRW Automotive (NYSE: TRW ) |
58% |
45% |
7% |
| Trinity Industries (NYSE: TRN ) |
157% |
6% |
10% |
Source: Capital IQ, a division of Standard & Poor's.
*Negative equity.
American Axle & Manufacturing's industry tends to employ moderate leverage. The company itself doesn't have a debt-to-equity ratio or return on equity because it doesn't have equity -- liabilities have outstripped assets since 2007. It has about $960 million in debt, compared with $2.2 billion in assets, and interest payments are about one-third of operating earnings (I generally like to see them below one-fifth.)
3. Management
CEO Richard Dauch has been at the job since he founded the company in 1994. Before starting the company, he spent more than a decade at Chrysler.
4. Business
Auto-parts manufacturing requires a bit of research and development, but it isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever buy American Axle & Manufacturing, we've learned that although the company has tenured management and operates in a straightforward industry, it doesn't particularly exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt.
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