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 E*TRADE (NAS: ETFC) -- 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 E*TRADE meet Buffett's standards?
1. Earnings powerBuffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine E*TRADE's earnings history:
Source: S&P Capital IQ.
Over the past five years, E*TRADE has had a difficult time generating consistent earnings, in large part because of losses on subprime mortgage holdings, though it's managed to recover somewhat over the past year.
2. Return on equity and debtReturn 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.
E*TRADE has been generating low returns on equity (3% over the past year, negative 19% on average of the past five years). The company has a debt-to-equity ratio of 195%.
3. ManagementCEO Steve Freiberg has been at the job only since 2010. Before that, he ran Citigroup's North American consumer segment and had been with Citigroup for decades.
4. BusinessDiscount brokerage may be somewhat susceptible to technological disruption; the business itself partially disrupted the traditional brokerage business only within the past few decades.
The Foolish conclusionSo is E*TRADE a Buffett stock? Probably not. While it's been turning around its operations, the company doesn't exhibit the characteristics of a quintessential Buffett investment: consistent earnings, high returns on equity with limited debt, long-tenured management, and a technologically straightforward business. However, if you'd like to stay up to speed on E*TRADE'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.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter, where he goes by@TMFDada. The Motley Fool owns shares of Citigroup. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't 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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