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 Alcatel-Lucent (NYS: ALU) -- 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.
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:
Consistent earnings power.
Good returns on equity with limited or no debt.
Management in place.
Simple, non-techno-mumbo-jumbo businesses.
Does Alcatel-Lucent 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 Alcatel-Lucent's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Alcatel-Lucent has had a difficult time generating earnings, though it's been turning things around over the past year.
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
Source: S&P Capital IQ.
Historically, Alcatel-Lucent hasn't generated very high returns on equity, though it has shown a dramatic improvement in recent years. It employs a considerable amount of debt.
CEO Ben Verwaayen has been at the job since 2008. His time at Alcatel-Lucent started in 1997, interrupted for a few years when he was CEO of the massive London-based telco BT Group.
Communications equipment requires constant research and development, but the industry isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
So is Alcatel-Lucent a Buffett stock? Probably not. The company has a tenured CEO, but it doesn't yet exhibit the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt. To stay up to speed on Alcatel-Lucent'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 Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of Cisco Systems. The Fool owns shares of and has created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of Cisco Systems. 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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