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 Metalico (AMEX: MEA) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal 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:

  1. Consistent earnings power.
  2. Good returns on equity with limited or no debt.
  3. Management in place.
  4. Simple, non-techno-mumbo-jumbo businesses.

Does Metalico 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 Metalico'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.

Metalico has had some difficulty maintaining consistent over the past five years, though they seem to be improving over the past couple of years.

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.



Return on Equity (LTM)

Return on Equity (5-Year Average)

Metalico 73% 12% 1%
Schnitzer Steel (Nasdaq: SCHN) 43% 10% 15%
Sims Metal Management (NYSE: SMS) 5% 5% 13%
Steel Dynamics (Nasdaq: STLD) 103% 10% 20%

Source: Capital IQ, a division of Standard & Poor's.

Metalico generates a moderately low return on equity while employing a moderate amount of debt.

3. Management
CEO Carlos Aguero has been at the job since he founded Metalico in 1997.

4. Business
Scrap metal recycling and fabrication isn't particularly susceptible to sudden technological disruption.

The Foolish conclusion
Whether or not Buffett would buy shares of Metalico, we've learned that, while the company has tenured management and operates in a straightforward industry, it doesn't exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt.

If you'd like to stay up to speed on the top news and analysis on Metalico or any other stock, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.