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 Hewlett-Packard
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 Hewlett-Packard 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 Hewlett-Packard'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, Hewlett-Packard has demonstrated fairly consistent 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.
|
Company |
Debt-to-Equity |
Return on Equity (LTM) |
Return on Equity (5-Year Average) |
|---|---|---|---|
| Hewlett-Packard |
55% |
22% |
20% |
|
IBM |
133% |
67% |
53% |
|
Dell |
91% |
45% |
53% |
|
Apple |
0% |
39% |
30% |
Source: Capital IQ, a division of Standard & Poor's.
Hewlett-Packard produces a lower return-on-equity ratio than its peers do, and it has a moderate debt-to-equity ratio.
3. Management
CEO Leo Apotheker has only been at the job since last September, though he has worked in the industry for some time.
4. Business
Computer hardware manufacturing isn't particularly susceptible to technological disruption, though it does require constant innovation. Buffett would probably be a bit reluctant to invest in the industry.
The Foolish conclusion
Regardless of whether Buffett would ever buy Hewlett-Packard, we've learned that, although the company does produce fairly consistent earnings, it doesn't exhibit many of the other characteristics of a quintessential Buffett investment: high returns on equity with limited debt and tenured management.
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