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 Exelon (NYS: EXC) -- 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 Exelon 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 Exelon's earnings and free cash flow history:
Source: S&P Capital IQ.
Exelon tends to generate fairly consistent -- though gradually declining -- earnings. (The free cash flow drop-off in 2011 was largely due to a spike in capital expenditures.)
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.
Exelon tends to generate fairly high returns on equity -- 18% over the past year, 23% on average over the past five years -- while carrying a moderate 94% debt-to-equity ratio. Those are some strong numbers for an electric utility.
CEO Chris Crane has been at the job since 2008. Before that, he held various other top spots in the company for a few years and has been in the nuclear industry for 25 years.
Though research is ongoing into alternative sources, electric utilities aren't particularly susceptible to rapid wholesale technological disruption.
The Foolish conclusion
So is Exelon a Buffett stock? It could very well be. The company exhibits several of the quintessential characteristics of a Buffett investment: fairly consistent earnings, high returns on equity with limited debt, tenured management, and a straightforward business.
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At the time thisarticle was published Ilan Moscovitz doesn't own shares of any company mentioned. Motley Fool newsletter services have recommended buying shares of Exelon. Motley Fool newsletter services have recommended creating a write covered straddle position in Exelon. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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