Is Linn Energy a Buffett Stock?

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 (Nasdaq: LINE  ) -- 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:

  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 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 (Nasdaq: LGCY  ) 115% (9%) 0%
EV Energy Partners (Nasdaq: EVEP  ) 55% 6% 22%
Quicksilver Resources (NYSE: KWK  ) 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.

If you’d like to stay up to speed on the top news and analysis on Linn Energy or any other stock, add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks by clicking here.

Ilan Moscovitz doesn’t own shares of any company mentioned. You can follow him on Twitter @TMFDada. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 22, 2011, at 11:51 AM, mrex27 wrote:

    I sure hope LINE isn't a company Buffet would like to take over because I don't want to give it up. it's a fabulously successful operation, pays excellent (7.75%) dividends and has very very low dividend risk over the next 4+ years. The div is set to start increasing rapidly and coverage is getting better every quarter.

    The analysis in this post is superficial and inappropriate. For the millionth time, MLP's (yeah I know it's technically a LLC) need totally different metrics than C corps to evaluate financial strength.

  • Report this Comment On August 24, 2011, at 5:55 PM, prginww wrote:

    What is most relevant and ignored by the author is the guaranteed revenue steam from presold/hedged production volumes for the next 4 years.

  • Report this Comment On August 24, 2011, at 5:56 PM, prginww wrote:

    I said stReam

  • Report this Comment On August 26, 2011, at 5:06 PM, ikkyu2 wrote:

    This article was copied nearly verbatim onto this site: http://turnkeyoil.com/2011/08/23/5142/

    Might take a look at that, I doubt they had Fool permission to just reprint the whole article.

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