Is Transocean a Buffett Stock?

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.

Company

Debt-to-Equity Ratio

Return on Equity

5-Year Average Return on Equity

Transocean 53% (2%) 20%
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.

3. Management
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.

4. Business
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.

Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of Devon Energy, Transocean, and Noble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 04, 2012, at 2:41 PM, TheDumbMoney wrote:

    "The drilling industry isn't especially susceptible to wholesale technological disruption, though it can be cyclical and sensitive to energy prices."

    I have actually recently been reevaluating my thesis on offshore drillers because of the disruption caused by onshore fracking. This is not disruption of the offshore business, but rather a parallel track that has to a certain extent (I'm trying to figure out to what extent) disrupted it. Before the rise of fracking, offshore drillers were a no-brainer. Now, even in light of the increasing regulation that will come to frackers, I'm less sure. That is especially so because particularly in such a capital-intensive business, as RIG is in, imo a lot of long-term growth has to be expected to come from overall expansion of the market, as opposed to coming from high returns on assets.

  • Report this Comment On January 04, 2012, at 3:17 PM, HigherLife wrote:

    Your missing a major part of the Buffett puzzle: a durable competitive advantage. I just don't see enough to separate RIG from it's competitors. It might be a solid investment, I haven't done enough research to securely state an opinion, but a Buffett pick it is not. There's some interesting numbers, but it's just missing a separating factor and as mentioned by dumberthanafool, such a capital-intensive business is another major knock on it.

  • Report this Comment On January 04, 2012, at 4:26 PM, DoctorLewis4 wrote:

    Really? Buffett tends to like companies with great management. That wouldn't be RIG.

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