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 Waste Management (NYSE: WM ) — 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 Waste Management 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 Waste Management’s earnings and free cash flow history:
Source: S&P Capital IQ.
Over the past five years, Waste Management’s earnings and free cash flow have been fairly steady, but they’re also declining, albeit slowly. Analysts believe Waste Management will reverse that trend this year.
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.
For its industry, Waste Management generates a strong return on equity — 16% over the past year, 17% on average over the past five years — while employing a somewhat large debt-to-equity ratio of 154%.
CEO David Steiner has been at the job since 2004. Before that, he was the company’s chief financial officer for a few years after being a partner at a law firm.
Garbage and recycling collection isn’t particularly susceptible to technological disruption.
The Foolish conclusion
So, is Waste Management a Buffett stock? It could be, though the picture is a little bit mixed. The company exhibits several of the quintessential characteristics of a Buffett investment: more-or-less consistent earnings, moderately high returns on equity, tenured management, and a straightforward business. Investors will still want to keep an eye Waste Management’s debt load as well as how well Waste Management is recovering from the company’s slight earnings slip of the past couple of years. If you’re looking for another great stock idea, check out our latest report: “The Motley Fool’s Top Stock for 2012.” It details a stock our chief investment officer picked to beat the market. I invite you to download this special report for a limited time by clicking here — it’s free.