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 Royal Caribbean (NYS: RCL) -- 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 Royal Caribbean 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 Royal Caribbean's earnings and free cash flow history:
Source: S&P Capital IQ.
Royal Caribbean tends to generate fairly consistent earnings despite the economic downturn. Free cash flow has been hugely negative due to the company's massive capital expenditures. That shouldn't be a problem, as long as it's able to generate good returns on those investments. Which brings us to the second characteristic.
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.
Royal Caribbean generates low returns on equity -- 7% both over the past year and on average over the past five years -- while carrying a moderately large debt-to-equity ratio of 101%.
CEO Richard Fain has been at the job since 1988. Prior to that, he spent over a decade at Gotaas-Larsen Shipping.
Cruises aren't particularly susceptible to technological disruption.
The Foolish conclusion
So is Royal Caribbean a Buffett stock? Probably not. Although the company has tenured management, consistent earnings, and a straightforward business, it doesn't particularly generate 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." 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. 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.