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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 Boston Scientific (NYSE: BSX ) -- 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 Boston Scientific 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 Boston Scientific's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past several years, Boston Scientific's earnings and free cash flow have been pretty volatile. A lot of those earnings losses came from goodwill impairments – writedowns-- on the company's assets, specifically product removals of its defibrillators.
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-to-equity ratio, 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.
Medtronic, St. Jude, and Stryker all produce consistently strong returns on equity with limited debt. Boston Scientific, on the other hand, has struggled a bit. And that's not just on account of its heavy writedowns. Whereas Medtronic produced a 21% operating margin over the past twelve months, St. Jude 25%, and Stryker 24%, Boston Scientific only managed 14%. And this disparity last year wasn't particularly unusual.
CEO William Kucheman has been at the job only since last October, though he has served in various other roles at the company since 1995.
The medical devices industry can require considerable research and development and is somewhat susceptible to technological disruption. Ideally, a company can develop a diversified group of high-moat products so that the loss of market share in a single one won't wreak havoc on revenues.
The Foolish conclusion
So, is Boston Scientific a Buffett stock? Probably not, as it doesn't particularly exhibit several of the quintessential characteristics of a Buffett investment: consistent earnings, high returns on equity with limited debt, and tenured management. However, if you're interested in a stock that our top analysts and chief investment officer picked to beat the market, you can check out "The Motley Fool's Top Stock for 2012." I invite you to download this special report for a limited time by clicking here -- it's free.