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 BP (NYSE: BP ) -- 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 a 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 BP 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 BP's earnings and free cash flow history:
Source: S&P Capital IQ.
While free cash flow has fluctuated a bit, mostly because of some large changes in working capital and some operational issues, BP's earnings have been fairly consistent -- with the big exception of 2010, when the company took a big hit for its role in the massive Deepwater Horizon oil spill.
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.
BP generates a fairly large return on equity -- 25% over the past year, 17% on average over the past five years -- while employing a limited debt-to-equity ratio of 39%.
CEO Robert Dudley has been at the job since October 2010. He's held various other roles over the past few decades at BP and Amoco before BP acquired it.
Although there have been major technological advancements in exploration and production over recent years, the industry isn't particularly susceptible to technological disruption.
The Foolish conclusion
So is BP a Buffett stock? It's a mixed picture. The company does operate in a non-disruptive industry and generates high returns on equity with limited debt. However, its CEO is somewhat fresh and the company has had trouble generating consistent earnings over the past few years. Most importantly, Buffett would probably need to make sure that he feels comfortable that management is cleaning up the sort of safety issues that led to the costly 2010 disaster. You can stay up to speed on BP's progress by adding it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks by clicking here.
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