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 Cliffs Natural Resources (NYS: CLF) -- 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 Cliffs 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 Cliffs' earnings and free cash flow history:
Source: S&P Capital IQ.
Cliffs' earnings have grown dramatically over the past several years.
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.
Return on Equity
5-Year Average Return on Equity
Cliffs Natural Resources
Alpha Natural Resources (NYS: ANR)
Arch Coal (NYS: ACI)
Patriot Coal (NYS: PCX)
Source: S&P Capital IQ. *Negative equity one or more years.
Cliffs tends to generate a very high return on equity while employing a moderate amount of debt.
CEO Kevin Sharer has been at the job since 2006. Prior to that, he worked at Rio Tinto in a number of positions over two decades.
Mining isn't particularly susceptible to technological disruption.
The Foolish conclusion
Regardless of whether Buffett would ever buy Cliffs, we've learned that the company actually exhibits several of the characteristics of a quintessential Buffett investment: consistent or growing earnings, high returns on equity with limited debt, tenured management, and a straightforward business. To stay up to speed on Cliffs' progress, 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 thisarticle was published Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. 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.
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