Is Krispy Kreme 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 Krispy Kreme (NYS: KKD) , 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 this series, we do just that.

Writing in a 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.

Although the company is probably too small for Buffett to literally buy, does Krispy Kreme 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 Krispy Kreme's earnings and free cash flow history:

anImage

Source: S&P Capital IQ.

Krispy Kreme took huge losses in 2006 and 2007, though it appears to be making something of a turnaround.

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.

Recently, Krispy Kreme has generated a high return on equity -- 24% over the past year, much better than its five-year average of -28%. It carries a moderately small debt-to-equity ratio of 27%.

3. Management
CEO Jim Morgan has been at the job since 2008. Prior to coming to Krispy Kreme, he worked on Wall Street.

4. Business
Doughnuts aren't particularly susceptible to technological disruption.

5. Tasty doughnuts
OK, maybe Buffett's 10-K doesn't specifically mention this, but Krispy Kreme does in fact make pretty tasty doughnuts.

The Foolish conclusion
So is Krispy Kreme a Buffett stock? It's too early to say. The turnaround is generating high returns on equity with limited debt, but it'll take some more time to know for sure.

If you're interested in another stock that our top analysts and chief investment officer picked to beat the market, you can check out The Motley Fool's Top Stock for 2012. I invite you to download this special report for a limited time by clicking here -- it's free.

At the time this article was published Ilan Moscovitz doesn't own shares of any company mentioned. 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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