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 Terra Nitrogen (NYSE: TNH) -- 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 this series, we do just that.

Writing 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 Terra Nitrogen 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 Terra Nitrogen's earnings and free cash flow history:

Source: S&P Capital IQ.

Terra Nitrogen's earnings fluctuate somewhat with commodity prices, but the company has remained profitable since 2003.

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 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.


Debt-to-Equity Ratio

Return on Equity

5-Year Average Return on Equity

Terra Nitrogen 0% 198% 108%
Agrium 41% 24% 16%
PotashCorp 61% 38% 32%
Mosaic 14% 22% 23%

Source: S&P Capital IQ.

Terra Nitrogen generates man outrageously high return on equity while employing no debt.

3. Management
Principal Executive Officer Stephen R. Wilson has been at the job since CF Industries (NYSE: CF) acquired the company in 2010. (CF currently owns 75% of Terra.) He's been the CEO of CF since 2003.

4. Business
Nitrogen fertilizer production isn't particularly susceptible to wholesale technological disruption, though it can be highly subject to commodity-price movements.

The Foolish conclusion
So is Terra Nitrogen a Buffett stock? While Buffett doesn't generally buy shares of commodity-driven companies (ConocoPhillips notwithstanding), the company does exhibit some of the characteristics of a quintessential Buffett investment: high returns on equity with limited debt, a tenured CEO, and it operates in a more-or-less straightforward industry. To stay up to speed on Terra Nitrogen's progress, 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.