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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 StoneMor (NYSE: STON ) -- 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.
Although it may be too small for him to literally buy, does StoneMor 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 StoneMor's earnings history:
Source: S&P Capital IQ.
StoneMor doesn't appear profitable when you look at its net income; however, the company actually generates consistent free cash flow because it so frequently receives payment in advance of providing its services.
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.
StoreMor doesn't technically produce a return on equity, because it has negative earnings, but we can estimate that over the past 12 months it generated a solid 15% cash flow return on average equity while employing a debt-to-equity ratio of 90%.
CEO Lawrence Miller has been running everyone's favorite cemetery partnership since it was founded in 2004. He has decades of experience at large cemetery holding companies.
Unless science discovers a cure for death, the cemetery business isn't particularly susceptible to technological disruption.
The Foolish conclusion
So is StoneMor a Buffett stock? It could very well be. The company exhibits several of the quintessential characteristics of a Buffett investment: consistent earnings, high returns on equity with limited debt, tenured management, and a straightforward business.
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