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 Advanced Micro Devices (NYSE: AMD ) -- 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 his most 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:
Does AMD 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 AMD's earnings and free cash flow history:
Source: S&P Capital IQ.
AMD's earnings have been quite volatile over the past several years, though they've recovered considerably since 2008.
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-to-equity ratio, 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.
| Company | Debt-to-Equity Ratio | Return on Equity | 5-Year Average Return on Equity |
|---|---|---|---|
| Advanced Micro Devices | 127% | 38% | (19%) |
| Intel | 16% | 27% | 19% |
| Texas Instruments | 51% | 21% | 23% |
| Marvell Technology | 0% | 15% | 5% |
Source: S&P Capital IQ.
These chip producers are all generating reasonable returns on equity at the moment. Though AMD's returns on equity haven't been great on average over a longer period, they have been reasonably solid in 2010 and 2011, even taking into account AMD's relatively large debt-to-equity ratio. Intel generates especially solid returns on equity for its limited debt load, which Texas Instruments is fairly consistent as well. Marvell, which focuses on ARM technology, tends to have more volatile earnings than the others.
3. Management
CEO Rory Read has only been at the job since August. Before that, he was the chief operating officer of Lenovo and had spent more than two decades at IBM.
4. Business
So far as tech companies go, AMD's products aren't historically susceptible to technological disruption. The company has been in a continued dogfight with Intel for a long time. However, new mobile processors from the likes of Marvell and Texas Instruments are pressuring PC sales as more consumers spend their discretionary dollars on tablets and smartphones. Continual innovation is very important in this industry, and Buffett might be a bit wary of investing in any semiconductor company, let alone one whose fortunes continually change as much as AMD.
The Foolish conclusion
So is AMD a Buffett stock? Probably not. Although the company generates reasonably high returns on equity, it doesn't particularly exhibit the other characteristics of a quintessential Buffett investment: consistent earnings, tenured management, and a straightforward industry. However, if you're interested in a semiconductor stock that our analysts think looks promising, you can check out "The Next Trillion Dollar Revolution." I invite you to download this special report by clicking here -- it's free.
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