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 Chesapeake Energy
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 Chesapeake Energy 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 Chesapeake Energy'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, Chesapeake Energy's earnings and free cash flow have been fairly volatile.
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) |
|---|---|---|---|
|
Chesapeake Energy |
67% |
6% |
3% |
|
Apache |
32% |
16% |
12% |
|
Anadarko Petroleum |
61% |
2% |
14% |
|
Devon Energy |
35% |
9% |
2% |
Source: Capital IQ, a division of Standard & Poor's.
Chesapeake Energy produces somewhat lower returns on equity than its peers while employing higher amounts of debt.
3. Management
CEO Aubrey McClendon has been at the job since 1989.
4. Business
Oil and gas exploration and production isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever buy Chesapeake Energy, we've learned that while the company has tenured management and operates in a straightforward industry, it doesn't particularly exhibit the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt.
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