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 Teva (Nasdaq: TEVA) -- 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 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.

Does Teva 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 Teva'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.

Over the past five years, Teva has somewhat volatile -- albeit growing -- earnings.

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 among peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context.



Return on Equity (LTM)

Return on Equity (5-Year Average)

Teva 29% 16% 11%
Bristol-Myers Squibb (Nasdaq: BMY) 34% 31% 26%
Eli Lilly (NYSE: LLY) 48% 40% 26%
Forest Labs (Nasdaq: FRX) 0% 21% 20%

Source: Capital IQ, a division of Standard & Poor's.

Teva produces a much lower return on equity ratio than its peers do, but it does have a significantly lower debt-to-equity ratio than they do.

3. Management
CFO Schlomo Yanai has been at the job since 2007.

4. Business
Generic pharmaceuticals aren't particularly susceptible to technological disruption.

The Foolish conclusion
Regardless of whether Buffett would ever buy Teva, we've learned that, although it doesn't generate exceptionally high returns on equity, it does exhibit some of the other characteristics of a quintessential Buffett investment: consistent or growing earnings power, tenured management, and a more-or-less simple industry.

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