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 Seaspan (NYS: SSW) -- 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 Seaspan 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 Seaspan's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Seaspan has struggled to maintain consistent earnings. Its heavy free cash flow shortfalls were largely because of the company's extensive capital investments. In other words, this is potentially not as significant a problem as they might appear -- but only if they generate high returns on investment.
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-to-equity ratio, 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
DryShips (NAS: DRYS)
Costamare (NYS: CMRE)
Source: S&P Capital IQ.
The financial crisis and energy volatility have been brutal to the highly leveraged shipping industry. Hardly anyone has generated decent returns on equity, and while Costamare has managed to do so, those returns are significantly inflated by the company's large debt-to-equity ratio. Even DryShips' reasonable average return on equity isn't as impressive upon closer inspection -- not only did it depend on a fair bit of leverage (114% may not be much in comparison to the others, but it ain't peanuts), but also on a strong 2007, whose results were driven in large part by asset sales rather than operations.
CEO Gerry Wang has been at the job since 2005. He's been at the company for more than two decades.
The shipping industry isn't particularly susceptible to technological disruption. Though, as we've seen above, it can be quite cyclical and dependent on energy prices and the state of the economy.
The Foolish conclusion
So is Seaspan a Buffett stock? Probably not. Even though the company has tenured management and operates in a technologically straightforward industry, it doesn't particularly exhibit some of the other characteristics of a quintessential Buffett investment: consistent earnings and high returns on equity with limited debt. However, if you're interested in a 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. It details a company revolutionizing commerce in Latin America. I invite you to download this special report for a limited time by clicking here -- it's free.
At the time thisarticle was published Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Seaspan. Motley Fool newsletter services have recommended creating a written covered straddle position in Seaspan. 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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