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 General Dynamics
Writing in a 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 General Dynamics 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 General Dynamics' earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, General Dynamics has generated pretty consistent earnings and free cash flow, though it remains to be seen to what extent industry stability will continue, given the possibility of looming defense cuts.
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.
General Dynamics generates high returns on equity (20% over the past year, 21% on average over the past five years). It carries a debt-to-equity ratio of 30%.
CEO Jay Johnson has been at the job since 2009. Before that, he was chief of naval operations for several years and was CEO of a power company.
While defense requires constant research and development, it isn't particularly susceptible to technological disruption for the major contractors like General Dynamics.
The Foolish conclusion
So is General Dynamics a Buffett stock? Perhaps. Although the CEO is relatively new to the job, he has had managerial and defense experience. The company also exhibits many of the quintessential characteristics of a Buffett investment: consistent earnings, high returns on equity with limited debt, and a straightforward business. If you'd like to stay up to speed on General Dynamics' progress, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks.
Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter, where he goes by @TMFDada. The Motley Fool owns shares of General Dynamics. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.