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 Sun Hydraulics
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 Sun Hydraulics 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 Sun Hydraulics' earnings and free cash flow history:
Source: S&P Capital IQ.
Sun Hydraulics' earnings have grown considerably over the past several years. (The momentary earnings decline in 2010 was due to weak sales.)
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.
Sun Hydraulics generates a high return on equity -- 29% over the past year, 20% on average over the past five years -- without employing any debt.
CEO Allen Carlson has been at the job since 2000. He's spent over three decades in the fluid power industry.
Hydraulic valves aren't particularly susceptible to technological disruption.
The Foolish conclusion
So, isSun Hydraulics a Buffett stock? It could very well be. The company exhibits several quintessential characteristics of a Buffett investment: (mostly) consistent or growing earnings, high returns on equity with limited debt, tenured management, and a straightforward business.
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Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Sun Hydraulics. Motley Fool newsletter services have recommended buying shares of Sun Hydraulics. 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.