Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, 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 Eli Lilly
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 Eli Lilly meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on sure things. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine Eli Lilly'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.
With the exception of 2008, Eli Lilly has exhibited fairly stable earnings.
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 to use an industry context.
|
Company |
Debt-to-Equity |
Return on Equity (LTM) |
Return on Equity (5-year average) |
|---|---|---|---|
| Eli Lilly | 48% | 40% | 26% |
|
Merck |
31% | 3% | 22% |
|
Johnson & Johnson |
30% | 22% | 27% |
|
Abbott Labs |
76% | 20% | 22% |
Source: Capital IQ, a division of Standard & Poor's.
Eli Lilly produces a fairly high return on equity while employing moderate debt.
3. Management
CEO John Lechleiter has served with the company for a number of years.
4. Business
Diversified pharmaceuticals require constant research and development, and pipeline difficulties are a threat. Nonetheless, the industry isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever buy Eli Lilly, we've learned that the company exhibits many of the characteristics of a quintessential Buffett investment: consistent earnings, high returns on equity with limited debt, and tenured management.
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