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 Innophos (NAS: IPHS) , 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 Innophos 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 Innophos' earnings and free cash flow history:
Source: S&P Capital IQ.
Innophos' earnings have fluctuated considerably over the past few years with the changing price of phosphates.
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.
Innophos generates a high return on equity -- 24% over the past year, 39% on average over the past five years. Although the company used to have a high debt-to-equity ratio, its leverage has come down over the years.
CEO Randy Gress has been at the job since Innophos split off from Rhodia in 2004. Before that, he worked in chemicals for Rhodia, FMC, and Ford.
Innophos' specialty chemicals aren't particularly susceptible to technological disruption.
The Foolish conclusion
So, is Innophos a Buffett stock? It's a mixed story. The company has tenured management and a straightforward business, and its high returns on equity are evidence of a competitive advantage. However, it doesn't tend to generate particularly consistent earnings.
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At the time thisarticle was published Ilan Moscovitz owns shares of Innophos. Motley Fool newsletter services have recommended buying shares of Innophos. 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.