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 Cisco (NAS: CSCO) -- 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 Cisco 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 Cisco's earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Cisco's earnings and free cash flow have held fairly steady.
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.
Cisco generates a moderately high return on equity -- 15% over the past year, 20% on average over the past five years -- while employing a moderately small debt-to-equity ratio of 34%.
What Cisco does with the cash it earns is another question. Cisco has spent tens of billions of dollars in recent years on share repurchases and billions more on acquisitions. Buffett's criticized companies for making ill-advised repurchases and acquisitions in the past, so he would need to feed comfortable with Cisco's capital allocation.
CEO John Chambers has been at the job since 1995. He's also worked for other large tech companies, including IBM, and served the George W. Bush and Clinton administrations' infrastructure and trade committees.
While Buffett might be a bit hesitant to invest in a tech-focused company such as Cisco, Internet routers aren't particularly susceptible to disruption so far as IT goes.
The Foolish conclusion
So is Cisco a Buffett stock? Probably not. The company has consistent earnings and tenured management. But Buffett would be a bit reluctant to invest in a company so focused on tech hardware, and he would have to be convinced that Cisco's acquisitions and share repurchases have been a prudent way to spend the company's moderately high returns on equity. If you're looking for other IT stock ideas, check out "3 Hidden Winners of the iPhone, iPad, and Android Revolution." I invite you to download this special free report for a limited time.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned. The Motley Fool owns shares of Cisco Systems and IBM. 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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