As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands track his investments and try to glean what they can from his thinking processes.
While we can't know for sure whether Buffett is about to buy Linn Energy
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 Linn Energy 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 Linn Energy’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, Linn Energy has struggled a bit to produce positive earnings.
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) |
|---|---|---|---|
| Linn Energy | 102% | (15%) | 5% |
|
Legacy Reserves |
115% | (9%) | 0% |
|
EV Energy Partners |
55% | 6% | 22% |
|
Quicksilver Resources |
183% | 40% | 7% |
Source: Capital IQ, a division of Standard & Poor's.
Like many of its peers, Linn Energy has tended to generate low-to-negative returns on equity while employing fairly high amounts of debt over the past few years.
3. Management
CEO Mark Ellis took the job in 2010 after the company’s founder gave up the spot (he still serves as chairman). Prior to that, he was the company’s COO for a few years, and he has worked for various other companies, including ConocoPhillips and Burlington Northern.
4. Business
The oil and gas exploration and production industry isn’t particularly susceptible to technological disruption.
The Foolish conclusion
Whether or not Buffett would buy shares of Linn Energy, we’ve learned that while it operates in a fairly technologically 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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