As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to track his investments and glean what they can from his thinking processes.
Although we can't know for sure whether Buffett is about to buy WellPoint
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.
- Simple, non-techno-mumbo-jumbo businesses.
Does WellPoint 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 WellPoint's earnings history.
Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.
WellPoint exhibited fairly stable earnings over the five-year period.
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 (LTM) |
Return on Equity (5-Year Average) |
|---|---|---|---|
| WellPoint | 41% | 22% | 14% |
|
UnitedHealth Group |
43% | 19% | 20% |
|
Coventry Health Care |
39% | 10% | 2% |
|
Aetna |
46% | 18% | 17% |
Source: Capital IQ, a division of Standard & Poor's.
WellPoint earned an above-average return on equity over the past 12 months. Over the past five years, its average return on equity has also done well. WellPoint's debt burden is about in line with those of its peers.
3. Business
Although no industry is completely immune to the vicissitudes of time, health insurance isn't the most prone to technological disruption -- we're not talking astro-nanorobotics here.
The Foolish conclusion
Regardless of whether Buffett would ever buy WellPoint, we've learned that the company exhibits several characteristics of a quintessential Buffett investment: stable earnings, high returns on equity with manageable debt, and a fairly straightforward business.
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