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 Oracle (Nasdaq: ORCL ) -- 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 Oracle 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 Oracle's earnings and free cash flow history:
Source: S&P Capital IQ.
Source: S&P Capital IQ.
Over the past several years, Oracle's earnings and free cash flow have grown steadily.
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.
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.
Oracle generates a high return on equity -- 24% both over the past year and on average over the past five years -- while employing a modest debt-to-equity ratio of 34%.
Larry Ellison has been CEO since he co-founded the company in 1977.
Databases and applications software are somewhat susceptible to technological disruption, but Buffett did recently buy a large stake in IBM, showing that he can be willing to buy tech companies so long as he sees a services moat wide enough to resist technological change. And the bulk of the Oracle's revenue does come from software license updates and services.
The Foolish conclusion
So is Oracle a Buffett stock? It's not an intuitive pick, but perhaps. The company exhibits several of the quintessential characteristics of a Buffett investment: consistent or growing earnings, high returns on equity with limited debt, and tenured management. While Buffett would be somewhat reluctant to invest in companies heavily involved in changing technologies, it's possible he'd be willing to overlook his usual aversion in the case of a higher-moat business like Oracle's.
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