Is Seadrill 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 Seadrill (NYS: SDRL) -- 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 Seadrill 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 Seadrill's earnings and free cash flow history:

anImage

Source: S&P Capital IQ.

Like many offshore contract drillers, Seadrill was hit hard during the economic downturn. Earnings have rebounded strongly; however, the company still spends considerably more on capital expenditures than it earns in cash from operations.

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.

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 Ratio

Return on Equity

5-Year Average Return on Equity

SeaDrill146%31%13%
Transocean (NYS: RIG) 53%(2%)20%
Ensco (NYS: ESV) 48%6%20%
Diamond Offshore (NYS: DO) 35%23%33%

Source: S&P Capital IQ.

Oil and gas drilling can be somewhat capital-intensive and competitive. Of the four names listed above, only Diamond Offshore produced a high return on equity over the past 12 months while carrying limited debt, although Transocean and Ensco have generated high returns on equity in the past. Seadrill's high returns on equity are in part the result of its above average debt-to-equity ratio.

3. Management
CEO Alf Thorkildsen has been at the job since 2008. Before that, he spent a couple of years at the company and two decades working for Shell.

4. Business
Oil and gas drilling may be high-tech in hard-to-recover areas, but it's not particularly susceptible to wholesale technological disruption.

The Foolish conclusion
So is Seadrill a Buffett stock? Probably not. Although its earnings have recovered and it has tenured management and a technologically straightforward industry, it doesn't exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt. However, if you'd like to stay up to speed on Seadrill'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.

At the time this article was published Ilan Moscovitz doesn't own shares of any companies mentioned. The Motley Fool owns shares of Transocean and Ensco. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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