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 Ford (NYSE: F) -- he hasn't specifically mentioned anything about it to me -- we can discover whether it's the sort of stock that might interest him. Answering that question could also inform whether it's a stock that should interest us.
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 Ford 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 Ford’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.
Ford’s earnings have been susceptible to the economic downturn, though the company has managed to rebound fairly dramatically.
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) |
|---|---|---|---|
|
Ford |
4,123% |
N/A |
N/A |
|
General Motors (NYSE: GM) |
32% |
25% |
N/A |
|
Toyota (NYSE: TM) |
115% |
4% |
6% |
|
Honda Motor (NYSE: HMC) |
90% |
12% |
10% |
Source: Capital IQ, a division of Standard & Poor's.
Ford technically doesn’t have a return on equity because the company had negative average equity over the past year, though the company has recently managed to stockpile positive equity for the first time since early 2008. It employs an enormous level of debt relative to equity.
3. Management
CEO Alan Mullaly has been at the job since 2006 and is frequently given much of the credit for Ford’s turnaround. Prior to working at Ford, he worked at Boeing for a number of years where he helped to turn around that company.
4. Business
Automobiles require constant reinvestment in research and development, though they’re not particularly susceptible to wholesale technological disruption in the same way as some high-tech industries.
The Foolish conclusion
Whether or not Buffett would buy shares of Ford, we’ve learned that, while the company has tenured management and a more-or-less straightforward industry, it doesn’t yet particularly exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt.
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