By Ilan Moscovitz | More Articles June 20, 2011 | Comments (1)
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 Chimera (NYSE: CIM ) -- 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:
Consistent earnings power. Good returns on equity with limited or no debt. Management in place. Simple, non-techno-mumbo-jumbo businesses.
Does Chimera 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 Chimera‘s earnings history: anImage
Source: Capital IQ, a division of Standard & Poor's. Chimera was founded in 2007.
Over the past four years, Chimera's earnings have grown dramatically as its portfolio has expanded. Mortgage REITs are fairly cyclical, so it's likely that Chimera's earnings will be as well.
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.
Chimera produces superior returns on equity while employing far less debt that its peers. But it’s important to understand that it does so by holding a higher-yielding (and potentially riskier) portfolio of mortgages.
3. Management Chimera is a fairly young company. CEO Matthew Lambiase has been at the Annaly Capital family of companies since 2004.
4. Business Mortgage REITs aren't particularly susceptible to technological disruption.
The Foolish conclusion Regardless of whether Buffett would ever buy Chimera, we've learned that, although it operates in a cyclical business, the company exhibits some of the characteristics of a quintessential Buffett investment: high returns on equity, tenured management, and a technologically straightforward business.