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 Sirius XM (Nasdaq: SIRI ) -- 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 Sirius XM 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 Sirius XM's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past several years, Sirius XM had a difficult time producing earnings and free cash flow. However, that's changed since fiscal 2010, and the company is now profitable.
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.
Return on Equity
5-Year Average Return on Equity
Source: S&P Capital IQ. *Negative equity for one or more years.
Since turning profitable, Sirius XM has been producing an enormous return on equity, though that is due in large part to the company's sizeable debt load.
CEO Mel Karmazin has been at the job since 2004 (when it was Sirius Satellite Radio). Before that, he'd spent several years at other broadcasters, including CBS and Viacom.
Fans of Sirius will point to the lack of meaningful direct competition in the satellite-radio industry, but the medium is new and could be vulnerable to technological disruption from indirect competitors.
The Foolish conclusion
Regardless of whether Buffett would ever buy Sirius XM, we've learned that while the company has tenured management, it doesn't particularly exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings, high returns on equity with limited debt, and a straightforward industry. To stay up to speed on Sirius XM'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.