Warren Buffett attracts a lot of attention. Since he's 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 Frontier Communications
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 Frontier 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 Frontier'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.
Earnings have shrunk a bit over the past five years, while free cash flow has been more-or-less steady. The acquisition of Verizon's rural assets is already beginning to lead to some earnings and free cash flow growth.
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) |
|---|---|---|---|
| Frontier | 166% | 6% | 21% |
|
Windstream |
934% | 38% | 92% |
|
CenturyLink |
99% | 5% | 11% |
|
Sprint Nextel |
139% | (21%) | (25%) |
Source: Capital IQ, a division of Standard & Poor's.
Frontier's industry tends to employ a fair bit of leverage. Over the last year Frontier generated fairly modest returns on equity, though its long-term average has been strong. Like many of its peers, the company employs moderately high leverage.
3. Management
CEO Mary Wilderotter has been at the job since 2004. Before starting the company, she worked at Microsoft, AT&T, and McCaw Cellular.
4. Business
Integrated telecommunications isn't particularly susceptible to wholesale technological disruption, though over the long term, wireline and long-distance communications could be increasingly supplanted by mobile phones.
The Foolish conclusion
Regardless of whether Buffett would ever buy Frontier, we've learned that the company generates fairly consistent earnings, has tenured management, and operates in a more-or-less technologically straightforward industry, though it doesn't particularly exhibit one of the other characteristics of a quintessential Buffett investment: high returns on equity with limited debt.
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