Is Krispy Kreme a Buffett Stock?

Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, thousands try to glean what they can from his thinking processes and track his investments.

While we can't know for sure whether Buffett is about to buy Krispy Kreme (NYSE: KKD  ) -- he hasn't specifically mentioned anything about it to me -- we can discover whether it's the sort of stock that might interest him. Answering that question could also inform 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:

  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.
  5. Delicious doughnuts.

Does Krispy Kreme 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 Krispy Kreme's earnings and free cash flow history:

Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.

Krispy Kreme took huge losses in 2006 and 2007, though it appears to be making something of a turnaround.

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 actually 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.

Company

Debt-to-Equity Ratio

Return on Equity

5-Year Average Return on Equity

Krispy Kreme 40% 16% (28%)
Flowers Foods (NYSE: FLO  ) 15% 18% 17%
Sara Lee (NYSE: SLE  ) 191% 27% 11%
Einstein Noah Restaurant (Nasdaq: BAGL  ) 105% 16% N/A*

Source: Capital IQ, a division of Standard & Poor's. *Negative equity one or more years.

Krispy Kreme produces a moderate return on equity while employing some debt.

3. Management
CEO James Morgan has been at the job since 2008.

4. Business
Doughnuts aren't particularly susceptible to technological disruption.

5. Delicious doughnuts
OK, maybe Buffett's 10-K doesn't specifically mention this desideratum, but Krispy Kreme makes pretty tasty doughnuts.

The Foolish conclusion
Regardless of whether Buffett would ever buy Krispy Kreme, we've learned that, while earnings have been somewhat volatile, the company exhibits some of the other characteristics of a quintessential Buffett investment: limited debt and a straightforward business.

If you'd like to stay up-to-speed on the top news and analysis on Krispy Kreme or any other stock, simply click here to add 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 companies mentioned. You can follow him on Twitter @TMFDada. Motley Fool newsletter services have recommended buying shares of Flowers Foods. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.


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