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 Diamond Foods
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.
Although the company is probably too small for Buffett to actually buy, does Diamond 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 Diamond's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Diamond's earnings have grown significantly, though we may be forced to take these numbers with a grain of salt. After recently announcing that it hadn't properly accounted for some payments to walnut growers -- $20 million in 2010 and $60 million in 2011 -- the company also revealed that earnings for those two years will have to be restated.
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.
Though its returns on equity are quite decent for the packaged foods industry, Diamond generates a somewhat low return on equity -- 12% over the past year, 11% on average over the past five years -- while employing a moderately large debt-to-equity ratio of 117%.
Acting CEO Richard Wolford took over earlier this month after the company's previous CEO and CFO were dismissed over the walnut payment scandal. Previously, he'd been in various other positions at Dole Foods and was CEO of Del Monte Foods and Del Monte Co. from 1997 to 2011.
Though some of the advanced things scientists have been able to do with packaged foods are pretty incredible, the industry isn't particularly susceptible to technological disruption.
The Foolish conclusion
So is Diamond Foods a Buffett stock? Probably not. The company does have a straightforward business and should still have consistent earnings once the restatements are completed. However, while Buffett has been able to take advantage of share price dips over corporate debacles in the past -- see his big investment in Coca-Cola after the "New Coke" debacle -- he would first need to be convinced of the new management's talent and integrity and that the company has a strong competitive advantage. However, if you're interested in a stock that our top analysts and chief investment officer picked to beat the market, you can check out The Motley Fool's top stock for 2012. I invite you to download this special report for a limited time by clicking here -- it's free.
Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Coca-Cola. Motley Fool newsletter services have recommended buying shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.