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 Potash Corp. of Saskatchewan
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.
Does Potash 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 Potash'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.
Potash's earnings fluctuate pretty substantially due to volatility in prices for its products.
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 |
Return on Equity (LTM) |
Return on Equity |
|---|---|---|---|
| Potash |
75% |
30% |
32% |
|
CF Industries |
34% |
23% |
31% |
|
Mosaic |
8% |
23% |
17% |
|
Agrium |
49% |
18% |
16% |
Source: Capital IQ, a division of Standard & Poor's.
Potash produces higher returns on equity than its peers, though it also bears a higher debt-to-equity ratio.
3. Management
CEO Bill Doyle has been at the job since 1999. Before that he served in other roles at the company for a number of years.
4. Business
Potash mining has long lead times, and fertilizer isn't particularly prone to technical disruption – we're not talking astro-bionanorobotics here.
The Foolish conclusion
Regardless of whether Buffett would ever buy Potash, we've learned that while the company's earnings are somewhat volatile and debt it a bit higher than peers', it does exhibit many of the other characteristics of a quintessential Buffett investment: high returns on equity, a simple industry, and tenured management.
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