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.
We can't know for sure whether Buffett is about to buy Krispy Kreme Doughnuts (NYSE: KKD ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal 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 Krispy Kreme 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 Krispy Kreme's earnings history:
Source: S&P Capital IQ.
Krispy Kreme took huge losses in 2006 and 2007, though it appears to be making something of a turnaround.
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 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 Ratio
|
Return on Equity
|
5-Year Average Return on Equity
|
| Krispy Kreme |
29% |
22% |
(28%) |
| Flowers Foods (NYSE: FLO ) |
40% |
17% |
17% |
| Sara Lee (NYSE: SLE ) |
134% |
19% |
13% |
| Einstein Noah Restaurant (Nasdaq: BAGL ) |
96% |
15% |
N/A* |
Source: S&P Capital IQ. *Negative equity one or more years.
Recently, Krispy Kreme has generated a pretty high return on equity while employing modest debt.
3. Management
CEO Jim Morgan has been in the position since 2008. Prior to coming to Krispy Kreme, he worked on Wall Street.
4. Business
Doughnuts aren't particularly susceptible to technological disruption.
5. Tasty doughnuts
OK, maybe Buffett's 10-K doesn't specifically mention this desideratum, but Krispy Kreme does in fact make pretty tasty doughnuts.
The Foolish conclusion
Regardless of whether Buffett would ever buy Krispy Kreme, we've learned that, while earnings have been somewhat volatile, it exhibits some of the characteristics of a quintessential Buffett investment: high returns on equity with limited debt and a straightforward business.
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