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 Verizon (NYSE: VZ ) -- 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 Verizon 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 Verizon's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Verizon's earnings and free cash flow have been fairly consistent, with the lone exception of 2008, which was marked by major restructuring charges.
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
|
| Verizon |
64% |
12% |
11% |
| AT&T (NYSE: T ) |
61% |
4% |
9% |
| Sprint Nextel (NYSE: S ) |
177% |
(22%) |
(30%) |
| CenturyLink (NYSE: CTL ) |
101% |
4% |
11% |
Source: S&P Capital IQ.
The telco industry is capital-intensive and, despite its oligopolistic structure, fairly competitive. None of these companies generates particularly high returns on equity, though Verizon scores the highest, and AT&T is doing all right. CenturyLink, which focuses more on Internet services, has historically produced a reasonable return on equity, but it carries a fair chunk of debt, too. Meanwhile, Sprint is struggling with losses and a large debt load.
3. Management
CEO Lowell McAdam has been at the job since August, though he was CEO of Verizon Wireless for a few years before that and has been in the telco industry a while.
4. Business
Despite its sometime reputation for stodgy dividend payers, the telco industry is somewhat susceptible to technological disruption. Just look at the difficulties Sprint has encountered keeping up with Verizon and AT&T's networks, or how all of the cell-service providers have increasingly become beholden to handset makers in just a few short years.
The Foolish conclusion
So is Verizon a Buffett stock? Probably not. Although it has generated consistent earnings over the past several years, it doesn't particularly exhibit the other characteristics of a quintessential Buffett investment: high returns on equity with limited debt, tenured management, and a technologically straightforward business. That being said, if you're looking for stocks to profit from the latest mobile trends, I invite you to check out "3 Hidden Winners of the iPhone, iPad, and Android Revolution."
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