As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. 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 SeaDrill (Nasdaq: SDRL ) -- 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:
- Consistent earnings power.
- Good returns on equity with limited or no debt.
- Management in place.
- Simple, non-techno-mumbo-jumbo businesses.
Does SeaDrill 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 SeaDrill'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.
Over the past few years, SeaDrill's net income has increased significantly. Free cash flow has been negative because of large capital investments.
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)
|
|
SeaDrill
|
137%
|
34%
|
13%
|
|
Transocean (NYSE: RIG )
|
53%
|
0%
|
20%
|
|
Ensco (NYSE: ESV )
|
48%
|
5%
|
20%
|
|
Diamond Offshore (NYSE: DO )
|
36%
|
25%
|
35%
|
Source: Capital IQ, a division of Standard & Poor's.
SeaDrill tends to generate fairly high returns on equity while employing fairly high amounts of debt.
3. Management
CEO Alf Thorkildsen has been only been at the job since 2008. Prior to that he'd served as CFO for a few years and worked at Shell for a couple of decades.
4. Business
Oil and gas drilling isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever invest in SeaDrill, we've learned that, while it doesn't generate high returns on equity with especially limited debt, it does exhibit some of the other characteristics of a quintessential Buffett investment: consistent or growing earnings (so far in its young history), tenured management, and a straightforward industry.
If you'd like to stay up-to-speed on the top news and analysis on SeaDrill 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.
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