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 Eastman Kodak (NYSE: EK ) -- 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 Eastman Kodak 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 Eastman Kodak's earnings and free cash flow history:
Source: S&P Capital IQ.
Eastman Kodak's had a difficult time generating net income over the past five years. Though much of that was due to restructuring charges and writedowns on investments, some are beginning to wonder if bankruptcy will be a necessary response to its cash burn.
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-Yr. Avg. Return on Equity
|
| Eastman Kodak |
N/A |
N/A |
N/A |
| Xerox (NYSE: XRX ) |
69% |
9% |
10% |
| Hewlett-Packard (NYSE: HPQ ) |
79% |
18% |
20% |
| Lexmark (NYSE: LXK ) |
43% |
24% |
24% |
Source: S&P Capital IQ. N/A = not applicable.
Eastman Kodak doesn't have a debt-to-equity ratio or a return on equity because it has negative equity.
3. Management
CEO Antonio Perez has been at the job since 2005, after serving as Kodak's COO for a couple of years. Before that, he worked for Hewlett-Packard for 25 years.
4. Business
The shift from film to digital cameras has taken a major toll on Kodak, whose trailing revenue has fallen to levels not seen in the last two decades (despite the fact that I still buy their colored film). The company hasn't been able to fully adjust, though transitioning to digital technologies has been one of Perez's goals.
The Foolish conclusion
Regardless of whether Buffett would ever buy Eastman Kodak, we've learned that while the troubled company has a tenured CEO, it doesn't particularly exhibit the other characteristics of a quintessential Buffett investment: consistent earnings, high returns on equity, and a straightforward industry. To stay up to speed on Eastman Kodak's progress, simply 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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