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 Frontline
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 Frontline 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 Frontline’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.
Though Frontline’s managed to stay earnings positive over the past five years, its earnings have fallen considerably since 2009 in response to the economic downturn.
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) |
|---|---|---|---|
|
Frontline |
361% |
13% |
57% |
|
Genco |
131% |
10% |
17% |
|
Ship Finance International |
240% |
17% |
28% |
|
General Maritime |
436% |
(73%) |
(6%) |
Source: Capital IQ, a division of Standard & Poor's.
Last year, Frontline produced a moderate return on equity, though returns were much higher during boom years. The company employs a considerable amount of debt, though that’s not terribly unusual for its industry.
3. Management
CEO John Fredriksen has been at the job since 1997.
4. Business
Oil and gas storage and transportation isn’t particularly susceptible to technological disruption. Although demand is a bit sensitive to the economic climate, as indicated by the earnings graph above, Frontline has managed to support its earnings better than many of its peers.
The Foolish conclusion
Regardless of whether Buffett would ever buy Frontline, we've learned that the company exhibits some of the characteristics of a quintessential Buffett investment; namely, fairly high returns on equity and tenured management, though he might prefer to see more consistent earnings and a lower debt-to-equity ratio.
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