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 KeyCorp (NYSE: KEY ) -- 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 KeyCorp 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 KeyCorp's earnings history:
Source: S&P Capital IQ.
Like much of the financial industry, KeyCorp's earnings took a big hit during the financial crisis in 2008 and 2009, though the bank's earnings have rebounded pretty dramatically.
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. Let's use a leverage ratio defined as assets divided by equity, which is commonly used for banks. In the United States, about 10 to 12 times is considered normal.
Return on Equity
5-Year Average Return on Equity
|Hudson City Bancorp||9.9||(15%)||4%|
|First Niagara Financial||6.8||5%||5%|
|People's United Financial||5.3||4%||3%|
Source: S&P Capital IQ.
Each of these banks has a fairly limited leverage ratio. With a flattening yield curve, a less-than-ideal loan environment, and fees getting hit across the board, these aren't especially great times for the banking industry. None of these companies generates a particularly high return on equity, though KeyCorp's is pretty impressive for the company's limited degree of leverage.
CEO Beth Mooney has been at the job since last May. Before that, she's held other positions at KeyCorp and has been involved with commercial banking for decades.
The banking industry isn't especially susceptible to technological disruption, but as the past several years have shown us, banks that delve too deeply into complexity and risk can be vulnerable to credit and economic cycles, as well as disasters of their own making. Megabank Wells Fargo is a major longtime Buffett holding, as are Bank of America preferred shares.
The Foolish conclusion
So is KeyCorp a Buffett stock? Perhaps. Although KeyCorp's CEO is somewhat new to the top spot, the company does exhibit several of the characteristics of a quintessential Buffett investment: consistent (or at least resilient) earnings, (reasonably) high returns on equity with limited debt, and a straightforward industry. If you're looking for some other bank stocks that might interest Buffett, check out The Motley Fool's "The Stocks Only the Smartest Investors Are Buying," which details a bank stock that shares the characteristics of a Buffett bank investment. I invite you to read this special report for free by clicking here.