Is Zipcar 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 Zipcar (NYSE: ZIP) -- 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:

1. Consistent earnings power.
2. Good returns on equity with limited or no debt.
3. Management in place.
4. Simple, non-techno-mumbo-jumbo businesses.

So, leaving aside the size of Zipcar, which might be too small for Buffett to literally buy, does it 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 Zipcar's earnings and free cash flow history:

Source: S&P Capital IQ.

As a young company that's trying to accumulate efficiencies of scale, Zipcar has posted earnings and free cash flow that have been substantially negative over the past few years.

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.

Source: S&P Capital IQ.

The car-rental industry is incredibly capital-intensive and competitive -- hence the enormous debt-to-equity ratios and historical unprofitability. Although Dollar Thrifty and Avis Budget have managed to generate high returns on equity over the past year, that's largely a result of their high debt-to-equity ratios.

3. Management
CEO Scott Griffith has been at the job since 2003. Before that, he was a founding partner of a consultancy and CEO of a now-bankrupt Internet company.

4. Business
Auto rentals aren't particularly susceptible to technological disruption, although Zipcar is attempting to disrupt its competitors with its unique membership business model.

The Foolish conclusion
So is Zipcar a Buffett stock? Probably not. Although it has tenured management and a technologically straightforward industry, it doesn't yet exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt. To stay up to speed on the top news and analysis on Zipcar or any other stock, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.