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 Textron (NYSE: TXT ) -- 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, 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 Textron 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 Textron'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.
Over the past five years, Textron's earnings have fallen dramatically while free cash flow has been much more steady, mostly as a result of provisioning for possible credit losses at the company's financing business, as well as some asset writedowns.
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)
|
| Textron |
159% |
5% |
16% |
| United Technologies (NYSE: UTX ) |
47% |
22% |
23% |
| General Electric (NYSE: GE ) |
362% |
12% |
16% |
| L-3 Communications (NYSE: LLL ) |
59% |
14% |
14% |
Source: Capital IQ, a division of Standard & Poor's.
Textron tends to generate moderately low returns on equity while employing moderately high amounts of debt.
3. Management
CEO Scott Donnelly has been at the job since 2009. Prior to that, he was the chief operating officer for a year (he still holds the COO spot as well) and had held a number of jobs at GE over about two decades.
4. Business
Though they can involve some research and development costs, aerospace, surveillance, and financing aren't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
Whether or not Buffett would ever purchase shares of Textron, we've learned that, while the company operates in fairly straightforward industries, 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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