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 Starbucks
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 Starbucks 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 Starbucks' earnings and free cash flow history:
Source: S&P Capital IQ.
Despite the economic downturn, Starbucks' earnings have grown considerably over the past several years. The free cash flow decline is mostly due to rising investments in inventory and capital improvements.
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.
Starbucks generates high returns on equity -- 29% over the past year, 23% on average over the past five years -- while employing a modest debt-to-equity ratio of 12%.
Co-founder and Chairman Howard Shultz took the CEO spot back in 2008 to help shore up the company's direction and operations, a move that has apparently been very successful.
Coffee isn't particularly susceptible to technological disruption.
The Foolish conclusion
So is Starbucks a Buffett stock? It could very well be. The company exhibits several of the quintessential characteristics of a Buffett investment: consistent or growing earnings, high returns on equity with limited debt, tenured management, and a straightforward business. To stay up to speed on the top news and analysis on Starbucks 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.
Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Starbucks and writing covered calls on Starbucks. 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.