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 Occidental Petroleum
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 Occidental Petroleum 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 Occidental Petroleum's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Occidental Petroleum's earnings and free cash flow have fluctuated somewhat with oil prices, but earnings have held fairly steady despite the economic downturn.
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.
|
Company |
Debt-to-Equity Ratio |
Return on Equity |
5-Year Average Return on Equity |
|---|---|---|---|
| Occidental Petroleum | 16% | 19% | 20% |
|
ExxonMobil |
10% | 27% | 28% |
|
ConocoPhillips |
42% | 18% | 7% |
|
Apache |
26% | 16% | 12% |
Source: S&P Capital IQ.
With high energy prices, the oil and gas exploration industry has been quite profitable over the past several years. Occidental and Exxon in particular have been generating high returns on equity with limited debt, while Conoco and Apache have generated reasonably strong returns on equity with modest debt, too.
3. Management
CEO Stephen Chazen has only been at the job since last May, although he has held a number of other positions at the company over the years, including CFO.
4. Business
Although the sudden economic downturn (which caught Buffett's energy investments by surprise, too) showed us that energy prices can be somewhat cyclical, oil and gas exploration and products isn't particularly susceptible to wholesale technological disruption. In fact, Buffett's company even owns shares of ExxonMobil and ConocoPhillips.
The Foolish conclusion
So is Occidental Petroleum a Buffett stock? It could very well be. It exhibits several of the characteristics of a quintessential Buffett investment: fairly consistent earnings, high returns on equity with limited debt, highly tenured management, and a technologically straightforward business. To stay up to speed on the top news and analysis on Occidental Petroleum 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.
Editor's note: A previous version of this article misidentified Occidental's executive chairman as its CEO. The Fool regrets the error.
