What Was Warren Thinking

Warren Buffet's buy of Burlington Northern is somewhat perplexing. The price he paid was not cheap at twenty times earnings. That is generally not the type of price that value investors like to pay. Warren Buffet has stated that he believes the value of the dollar will fall. That would help explain why he would overpay for a company. However, he used Berkshire stock to help pay for the deal as well. Unless he believes his stock is overvalued as well it is hard for me to make sense of this deal.

12 comments:

Anonymous said...

Most people don't seem to understand the deal. Therefore, he's "buying, when others are selling." If it was a well understood deal, there wouldn't be the opportunity.

Tsachy Mishal said...

20 times earnings for a slow grower seems like a lot of money. Buffett is only human. It is not impossible that he is making a mistake. He has made some in the past.

Tsachy Mishal said...

Warren Buffet's array of companies likely ship a lot of goods. Maybe he plans to shift all the traffic to BNI.

Anonymous said...

Who is Warren?

Warren G?

Time to regulate!!!

Sold ABK @ 1.49

$$$ Money Dolla dolla Billz ya'llszzzz

Tsachy Mishal said...

I dont know who you are but I thought about you when I saw the ABK earnings this morning. congrats.

Anonymous said...

Thanks dawg.

PJ said...

His stock is overvalued ... Nice thing about the 50:1 split is it makes it shortable.

Fred said...

Buffett started transitioning from an investor to an insurance company CEO about 15 years ago and this pretty much completes the transition. The insurance company is immensely profitable and that sector has a good long-term outlook if well-managed. But insurance companies need someplace to store their float. Bonds pay very little and are subject to inflation risk. Commercial RE, the other traditional investment of insurance companies, has all sorts of problems. Stocks have a much better long-term expected return than bonds or real-estate, even at 20 PE, but have usually been considered too risky for insurance companies. So Buffett has been concentrating lately on the less volatile stocks, like utilities and now BNI. Both utilities and railroads have hard assets which can be mortgaged easily if the insurance company needs a bunch of cash in a hurry. In other words, the insurance operations of Berkshire Hathaway is the profit source and everything else is there merely to backstop the insurance operations.

Tsachy Mishal said...

Fred,
Well said but why issue the Berkshire shares?

Fred said...

Buffett has always said proper management behavior would consist in issuing new shares when the share price is high and buying shares back when the price is low, so as to push price back towards intrinsic value (as determined by the managers). So maybe he is doing just that. That is, he think BRK is priced too high in relation to BNI, so that long-term BRK shareholders are well served by an implied trade of some of their BRK equity for equity in BNI. But I haven't thought too carefully about the deal. Like I said, Buffett is now mostly the CEO/majority owner of an insurance company, and all his actions should be seen in that context.

Fred said...

Also, I'm not sure the price is excessive, since he buying the company lock, stock and barrel. Which means the managers won't be able to p*ss away the profits on stupid acquistions of their own or steal all the profits in the form of stock options. That P/E of 20 translates to an earnings yield of 5%. With a little leveraging, which isn't dangerous for something as capital intensive as a railroad, he can push that to 10%. Then using the railroad to backstop more insurance operations and he can get a return on equity of 15%, which I believe is his long-term target. And this is a safe and guaranteed return, since neither insurance nor railroads are ever going away.

The dark side to a Buffett's actions and non-actions over the last decade is that he appears to think the great age of brandnames (Coca-cola et al) is over, and I tend to agree. Consumers are now (a) eager to try new brands in order to be different from everyone else (contrast with the desire to be the same as everyone else in the conformist 1950's) and (b) willing to try new brands to save money. That trend spells danger for pharmaceuticals which rely on brand-name rather than patent protection. Also, I think Buffett believes an age of profitless prosperity and cut-throat competition may await many sectors, as it has many times in the past in capitalism. Railroads have the biggest moat of any industry around.

As a small investor, I wouldn't buy railroads (other than as part of an index fund) but I can see Buffett's rationale.

Anonymous said...

I'm going to call you "Well Said Fred" from now on...

You're spot on.