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 SandRidge 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 SandRidge 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 SandRidge’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.
SandRidge has had difficulty producing earnings and free cash flow over the past five years. However, it’s important to note that the large net-income losses in 2008 and 2009 were due to asset impairment charges and that the free cash flow shortfalls are due to major capital investments the company has been making. Operating cash flow has been fairly steady, however.
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 Avg.) |
|---|---|---|---|
| SandRidge Energy | 162% | 4% | (131%) |
|
Ultra Petroleum |
130% | 33% | 20% |
|
Whiting Petroleum |
38% | 13% | 10% |
|
Continental Resources |
45% | 6% | 27% |
Source: Capital IQ, a division of Standard & Poor's.
For the reasons discussed above, SandRidge hasn’t generated very high returns on equity over the past few years. The company carries moderately high amounts of debt.
3. Management
CEO Tom Ward has been at the job since 2006. Prior to that, he was CEO of Integra Energy and founded Chesapeake Energy in 1989.
4. Business
Though new technologies are being developed in the industry, oil and gas exploration and production isn’t particularly susceptible to technological disruption.
The Foolish conclusion
So is SandRidge a Buffett stock? Well, it’s a mixed story. Whether or not Buffett would buy shares of SandRidge, we’ve learned that, while it has tenured management and operates in a technologically straightforward industry, it doesn’t exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings (unless we look at operating cash flow) and high return on equity with limited debt.
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