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 United Technologies (NYS: UTX) -- 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 United Technologies 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 United Technologies' earnings and free cash flow history:
Source: S&P Capital IQ.
Despite the fact that recession-resistant defense spending only makes up about 20% of United Technologies revenue, earnings and free cash flow have stayed remarkably consistent during the economic downturn.
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
Source: S&P Capital IQ.
United Technologies earns a fairly impressive return on equity while carrying a reasonable amount of debt. In the long-run, its $16.5 billion acquisition of Goodrich (NYS: GT) , which will be financed by a mixture of stock, debt, and (most recently revealed) asset sales, should help improve margins.
CEO Louis Chenevert has been at the job since 2008, although he's been at the company for at least a decade longer in various other roles after spending time at General Motors.
The airplane component business requires constant research and development, but it isn't particularly susceptible to wholesale technological disruption.
The Foolish conclusion
So, is United Technologies a Buffett stock? It very well could be. The company exhibits several of the quintessential characteristics of a Buffett investment: consistent or growing earnings, reasonably high returns on equity with limited debt, tenured management, and a straightforward business. 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. 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 Moscovitzdoesn't own shares of any company mentioned.The Motley Fool owns shares of L-3 Communications Holdings.Motley Fool newsletter serviceshave recommended buying shares of L-3 Communications Holdings and General Motors. 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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