Is BP 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 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:

  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.

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%.

3. Management
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.

4. Business
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.

Ilan Moscovitz doesn't own shares of any company mentioned. Motley Fool newsletter services have recommended buying shares of Netflix, Procter & Gamble, and BP. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 25, 2012, at 3:18 PM, cbhsboy wrote:

    I bought BP right after the oil spill. Looking at the companies fundamentals and the fact that a large amount of the UK pension plan system is backed with BP stock, I felt that there was no way that the company would be allowed to go under. It was simply too vital to the interests of the UK. Bought in at about $30 and have held ever since. The company has a long history of goo performance and though they had a hiccup-a big one- they will still perform.

  • Report this Comment On February 25, 2012, at 3:18 PM, cbhsboy wrote:

    sorry --- company's

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