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 United Parcel Service
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 UPS 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 UPS' 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.
UPS has maintained fairly stable earnings over the past five years. (The 2007 plunge was largely due to a major pension-related charge.)
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) |
|---|---|---|---|
|
UPS |
147% |
48% |
27% |
|
FedEx |
11% |
10% |
9% |
|
Union Pacific |
51% |
16% |
13% |
|
Norfolk Southern |
64% |
15% |
15% |
Source: Capital IQ, a division of Standard & Poor's.
UPS produces a superior return on equity, though that feat is achieved in part by a debt-to-equity ratio that’s higher than its peers’.
3. Management
CEO D. Scott Davis has been at the job since 2008. Since 1986, he’s served in basically every conceivable senior role at UPS.
4. Business
Shipping isn’t particularly susceptible to wholesale technological disruption, though UPS has benefited from the move away from big box retailing to the Internet. It’s possible that a prolonged period of higher gas prices could benefit railroads over air and trucking.
The Foolish conclusion
Regardless of whether Buffett would ever buy UPS, we've learned that the company exhibits some of the characteristics of a quintessential Buffett investment: reasonably consistent earnings, high returns on equity (albeit with a higher-than-average dose of debt), tenured management, and a reasonably straightforward industry.
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