Is VMware a Buffett Stock?

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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 VMware (NYS: VMW) -- 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:

  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 VMware 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 VMware's earnings and free cash flow history.

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

Over the past five years, VMware has grown its earnings pretty significantly.

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 among 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)

VMware, Inc.10%14%30%
Oracle (NAS: ORCL) 40%24%24%
NetApp (NAS: NTAP) 33%20%15%
Citrix Systems (NAS: CTXS) 0%13%11%

Source: Capital IQ, a division of Standard & Poor's.

VMware produces a rather high return-on-equity ratio compared with its peers while employing little debt.

3. Management
CEO Paul Maritz has been at the job since 2008. He's worked in the computer industry for some 30 years, working in software development for Intel, and managing software development and cloud computing projects for Microsoft.

4. Business
Virtualization and cloud computing are pretty susceptible to technological disruption. It might be a burgeoning field, but it's not one Buffett would personally feel comfortable with due to its high rate of change and his lack of knowledge about it.

The Foolish conclusion
Regardless of whether Buffett would ever buy VMware, we've learned that, although the company operates in an industry that he would probably shy away from, it does exhibit many of the other characteristics of a quintessential Buffett investment: growing earnings, high returns on equity with limited debt, and tenured management.

If you'd like to stay up to speed on the top news and analysis on VMware or any other stock, simply add it to your stock watchlist. If you don't have one yet, click here to create a free, personalized watchlist of your favorite stocks.

At the time this article was published Motley Fool Financial EditorIlan Moscovitzdoesn't own shares of any company mentioned. You can follow him on Twitter at@TMFDada.The Motley Fool owns shares of Oracle, Intel, and Microsoft, and has bought calls on Intel.Motley Fool newsletter serviceshave recommended buying shares of Microsoft, VMware, and Intel, creating a diagonal call position in Intel, and creating a bull call spread position in Microsoft. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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