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.

While we can't know for sure whether Buffett is about to buy Chesapeake Energy (NYSE: CHK) -- he hasn't specifically mentioned anything about it to me -- he has left us some clues as to whether it's the sort of stock that might interest him. Answering that question could also inform whether it's a stock that should interest us.

In his most recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size and a reasonable valuation, he demands:

  1. Consistent earnings power.
  2. Good returns on equity with limited or no debt.
  3. Management in place.
  4. Simple, non-techno mumbo jumbo businesses.

Does Chesapeake 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 Chesapeake's earnings and free cash flow history:

Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.

Chesapeake has had pretty wild fluctuations in its earnings and free cash flow over the past few years. Of course, this is to be expected for natural gas producers during a global recession.

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 actually 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 use an industry context:


Debt-to-Equity Ratio

Return on Equity (LTM)

Return on Equity (5-year average)

Chesapeake Energy




Devon Energy (NYSE: DVN)








Southwestern Energy (NYSE: SWN)




Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months.

Chesapeake has higher leverage than its peers, and it doesn't appear to have generated above-average returns on equity to show for it.

3. Management
Chesapeake's Chairman and CEO, Aubrey McClendon, has been at the job since 1989, though the spat over his pay and benefits probably wouldn't endear him to Buffett.

4. Business
Natural gas production isn't generally an industry considered ripe for massive technological disruption.

The Foolish conclusion
Whether or not Buffett would ever invest in Chesapeake Energy, we've learned that the company doesn't bear at least two of the quintessential characteristics of a Buffett investment: consistent earnings power, and high returns on equity with little debt.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool editor Ilan Moscovitz doesn't own shares of any company mentioned. Chesapeake Energy is a Motley Fool Inside Value choice. The Fool owns shares of Chesapeake Energy and Devon Energy. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.