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 Archer Daniels Midland
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 Archer Daniels Midland 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 Archer Daniels Midland’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, Archer Daniels Midlandhas maintained fairly stable earnings. (Free cash flow fluctuates considerably with changes in inventory and receivables).
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 (5-Year Average) |
|---|---|---|---|
| Archer Daniels Midland | 85% | 13% | 15% |
|
Smithfield Foods |
60% | 17% | 4% |
|
Bunge |
36% | 21% | 13% |
|
Tyson Foods |
43% | 17% | 2% |
Source: Capital IQ, a division of Standard & Poor's.
Archer Daniels Midland produces a reasonable return on equity while employing moderate debt.
3. Management
CEO Patricia Woertz has been at the job since 2006.
4. Business
Trading agriculture products isn't particularly susceptible to technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever buy Archer Daniels Midland, we've learned that the company exhibits some of the other characteristics of a quintessential Buffett investment: consistent earnings, tenured management, and a straightforward industry, though Buffett might prefer to watch the company to see if it can generate somewhat higher returns on equity.
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