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 Hewlett-Packard
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 Hewlett-Packard 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 Hewlett-Packard's earnings and free cash flow:
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author’s calculations.
Hewlett-Packard’s earnings have grown slightly over the past five years.
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) |
|---|---|---|---|
| Hewlett-Packard | 66% | 23% | 20% |
|
IBM |
128% | 69% | 53% |
|
Dell |
93% | 49% | 53% |
|
Cisco |
36% | 14% | 20% |
Source: Capital IQ, a division of Standard & Poor's.
Hewlett-Packard tends to generate moderately high returns on equity while employing a moderate amount of debt.
3. Management
CEO Leo Apotheker has been at the job since he replaced Mark Hurd last year. He came to Hewlett-Packard after spending a number of years at SAP.
4. Business
Computer hardware may not be totally susceptible to wholesale, unexpected technological disruption. But it requires constant investment in research and development to remain innovative -- something the company has been accused of neglecting in recent years.
The Foolish conclusion
Whether or not Buffett would buy shares of Hewlett-Packard, we’ve learned that, while the company generates consistent earnings and produces reasonably high returns on equity with only moderate debt, it doesn’t yet exhibit some of the other characteristics of a quintessential Buffett investment: tenured management and a straightforward business.
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