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 Transocean (NYSE: RIG ) -- 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 Transocean 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 Transocean's earnings and free cash flow history:
Source: S&P Capital IQ.
Tempered energy prices and the economic downturn have dampened Transocean's earnings, though the company has managed to maintain high free cash flow by cutting back on capital expenditures. (2010's and the past 12 months' earnings were also hurt by a large asset writedown.)
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
|Weatherford International (NYSE: WFT )||77%||3%||10%|
|Devon Energy (NYSE: DVN )||44%||11%||2%|
|Noble (NYSE: NE )||48%||5%||26%|
Source: S&P Capital IQ.
Transocean’s net income was unusually low over the past 12 months. In fact, none of these oil and gas drilling services providers generated a substantial return on equity over the past 12 months. The past two years just haven’t been kind to the industry. Only Devon Energy broke the two-digit mark, and even its return probably isn’t nearly enough to tempt Buffett. Transocean and Noble, however, have historically generated the sorts of returns on equity that we’re looking for.
CEO Steven Newman has been at the job since 2010. Before that, he served as the company's chief operating officer and in various other positions for several years.
The drilling industry isn't especially susceptible to wholesale technological disruption, though it can be cyclical and sensitive to energy prices.
The Foolish conclusion
Whether or not Buffett would buy shares of Transocean, we've learned that to some extent it normally exhibits the characteristics of a Buffett investment: more-or-less consistent earnings power, fairly high returns on equity with limited debt, and a straightforward business, though it's possible Buffett would also like to watch the company to see how its CEO fares in his new role. To stay up to speed on Transocean's turnaround, 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.