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 Rambus (Nasdaq: RMBS) -- he hasn't specifically mentioned anything about it to me -- he has left us some clues as to 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 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 Rambus 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 Rambus' 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.

Rambus doesn't have a strong history of producing earnings or free cash flow, but the trailing 12 months were awesome, thanks to surging revenue.

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 use an industry context:


Debt-to-Equity Ratio

Return on Equity (LTM)

Return on Equity (5-year average)





ARM Holdings (Nasdaq: ARMH)




Synopsys (Nasdaq: SNPS)








Source: Capital IQ, a division of Standard & Poor's. Median average reflects a basket of companies which are not all shown above.

Rambus exhibits somewhat higher-than-average debt-to-equity, and its trailing return on equity is substantially higher than its peers.

3. Management
Rambus' CEO, Harold Hughes, has been at the job since 2005. Before that, he had spent decades at Intel.

4. Business
DRAM and semiconductors are fields that are highly vulnerable to competing technological innovation. Rambus has valuable patents, but the field is high complex and the company requires a high degree of technical knowledge to understand.

The Foolish conclusion
Whether or not Buffett would ever invest in Rambus, we've learned that it currently exhibits higher-than-average return on equity with modest debt, and it's run by a CEO with some time under his belt. However, the company doesn't bear at least two of the quintessential characteristics of a Buffett investment: protection from technological innovation and a history of earnings stability.

Fool editor Ilan Moscovitz doesn't own shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.