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 Clorox (NYS: CLX) -- 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 this series, we do just that.
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 Clorox 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 Clorox's earnings and free cash flow history:
Source: S&P Capital IQ.
Clorox's earnings have been remarkably consistent over the past five 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
Procter & Gamble (NYS: PG)
Church & Dwight (NYS: CHD)
Newell Rubbermaid (NYS: NWL)
Source: S&P Capital IQ. *Negative equity one or more years.
Clorox generated an enormous return on its average equity over the past 12 months, but that's because the company only has a tiny amount of equity -- in fact, its most recent quarter ended with equity in the red. Compared to its peers, Clorox does have reasonably high operating margins.
CEO Donald Knauss has been at the job since 2006. Prior to that, he held a number of other jobs for Coca-Cola over the years, including chief operating officer.
Cleaning products aren't particularly susceptible to technological disruption.
The Foolish conclusion
So is Clorox a Buffett stock? Possibly. Clorox exhibits several of the other characteristics of a quintessential Buffett investment: consistent or growing earnings, tenured management, and a straightforward business, though Buffett might prefer to see its overall debt levels come down somewhat. To stay up to speed on Clorox's 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 Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter@TMFDada. The Motley Fool owns shares of Coca-Cola and Clorox.Motley Fool newsletter serviceshave recommended buying shares of Coca-Cola and Procter & Gamble. 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.
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