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 PotashCorp (NYSE: POT ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal 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, 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 PotashCorp 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 PotashCorp's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, PotashCorp's earnings have fluctuated a bit along with potash prices, but they've held reasonably steady given the magnitude of the current economic upheaval.
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.
Si nce 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 Ratio | Return on Equity | 5-Year Average Return on Equity |
|---|---|---|---|
| PotashCorp | 58% | 42% | 36% |
| CF Industries (NYSE: CF ) | 34% | 33% | 31% |
| Mosaic (NYSE: MOS ) | 14% | 22% | 23% |
| Agrium (NYSE: AGU ) | 37% | 26% | 21% |
Source: S&P Capital IQ.
The fertilizer industry is fairly concentrated with some barriers to entry. Potash production has especially long lead times for new projects. All of the companies above continue to generate strong returns on equity with modest amounts of debt.
3. Management
CEO Bill Doyle has been at the job since 1999. Before that he served in other roles at the company for a number of years.?
4. Business
Fertilizer isn't particularly prone to technical disruption -- we're not talking astro-bionanorobotics here.
The Foolish conclusion
So is PotashCorp a Buffett stock? It could very well be. The company exhibits several of the characteristics of a quintessential Buffett investment: more-or-less consistent earnings, high ret! urns on equity with limited debt, tenured management, and a technologically straightforward business. To stay up to speed on PotashCorp's progress, or that of 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 by clicking here.
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