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 DryShips (Nasdaq: DRYS ) -- 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 this series, we do just that.
Writing 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 DryShips 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 DryShips' earnings and free cash flow history:
Source: S&P Capital IQ.
Over at least the past five years, DryShips' earnings have been volatile due to rocky shipping demand. Free cash flow fell over the past couple of years due to some serious capital expenditures.
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.
DryShips hasn't generated very high returns on equity. It employs a considerable amount of debt.
CEO George Economou has been at the job since 2004. Prior to that, he was a superintendent engineer at Thenamaris Ship Management and founded Cardiff Marine in 1986.
Dry bulk carriers and drilling rigs aren't particularly susceptible to technological disruption, though the industry can be subject to a fair bit of cyclicality, as we've seen.
The Foolish conclusion
So is DryShips a Buffett stock? Probably not. The company has a tenured CEO and operates in a fairly straightforward industry, but it doesn't particularly exhibit the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt. To stay up to speed on DryShips' 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.