By Tom Stevenson
Published: 8:53PM GMT 07 Nov 2009
On the face of it a big but unexciting deal, it gets better and better the more you think about it – contrarian investing at its finest.
The conventional wisdom, especially in America, is that railways are yesterday's story, a relic from the days before Eisenhower's interstates criss-crossed the country in the 1950s to confirm the victory of the car and truck. The deal defies a second piece of 'crowd-think' too - that America is doomed to play second fiddle to the explosive growth of the world's emerging markets. As Buffett conceded, this is an "all-in wager" on America's future.
Buffett's reputation as the world's most successful investor hangs on his ability to buy a good business when most other investors dislike or are at best indifferent to it. When he bought General Foods and Coca-Cola in the 1980s, Wall Street could think of little good to say about either purchase. General Foods was seen as a no-growth food manufacturer while Coke was just a safe, conservative, but pretty unattractive, portfolio staple.
However, after Buffett bought shares in General Foods, its earnings grew rapidly as commodity deflation reduced costs while consumer spending increased. By the time he sold out to Philip Morris in 1985, Buffett's investment had tripled. In the first 10 years after he bought Coca-Cola, its shares rose more than eight-fold.
The acquisition of Burlington Northern could be just such a piece of contrarian lateral thinking. Buffett's gamble is that the railways will be seen as a low-cost, environmentally-friendly alternative to the roads if the oil price continues its upward trend. It is, therefore, not so much a bet against emerging growth as a sideways play on it.
But the real attraction to Buffett of a deal like this is that the market's pervasive pessimism means he can pick up the company for a song. He is buying a business with a near-impregnable market position (no-one's going to build a rival rail network in the western US) for around nine times operating profits. Buffett can not only afford to wait, he can even afford to be a bit wrong - the ultimate margin of safety.
Buffett has become one of the world's richest men by looking the other way from the rest of the crowd, but it's something every investor can do if they can avoid the easy temptation to go with the herd.
We've been here before. In February 2000, the technology stock bubble was reaching its mad climax, Vodafone had just overpaid for Mannesmann and investors were stampeding to buy shares in loss-making lastminute.com – the high-water float of the internet boom. Amid all this madness, you could have bought shares in Whitbread for 446p, a price that represented about seven times the company's expected earnings.
At that price, its dividend would have given you an income of 6.5pc. The book value of the company's assets (which then comprised an unfashionable collection of brewing, pubs, hotel and health club businesses) was 750p, half as much again as the share price.
This was classic Buffett territory and, perhaps unsurprisingly, the outcome for a contrarian investor was Buffett-style rewards. For the first three years, a period during which the FTSE 100 fell by almost 40pc, the shares moved sideways. Then they really took off as investors regained their appetite for the stock market. By the time they peaked in April 2007, Whitbread shares had risen to more than £19. Even today, after a two-year roller-coaster, an investor who has reinvested their dividends throughout the past 10 years has tripled their money. Even with the benefit of re-invested dividends, the market as a whole has gone nowhere over the same period.
So, given that Buffett has already picked up Burlington Northern, where should you look for counter-intuitive bargains today? My first stop is always to see what investors are not buying by looking at the fund flows at the website of the Investment Management Association.
No surprises there. The biggest net outflows in September were once again from funds invested in Japan - the country that liked the lost decade so much it decided to repeat it. The Nikkei index, at around 10,000, still stands about 75pc lower than it did 20 years ago, when it peaked just below 39,000. Predicting an end to the slow strangulation of the Japanese stock market has been a mug's game for nearly a generation.
The numbers don't lie, but the almost total lack of interest in what remains a stable and prosperous economy, the world's second largest, is a good sign for Buffett-esque contrarians. With a new government offering the prospect of political change and structural reform, a unique position as a back-yard exporter to the world's fastest-growing region and share prices which have finally shaken off the overvaluation that made them so unattractive two decades ago, perhaps Japan is the Burlington Northern of the East.
Tom Stevenson is an investment commentator at Fidelity International. The ideas expressed are his own.
Share Investor Blog - Stockmarket & Business commentary
Share Investor New Zealand Business News- Get more business news
Discuss this topic @ Share Investor Forum
Share Investor's Daily Forex Updates
Recommended Amazon Reading
|The Essays of Warren Buffett: Lessons for Corporate America, Second Edition by Warren E. Buffett |
Buy new: $26.31 / Used from: $35.00
Usually ships in 24 hours
|The Snowball: Warren Buffett and the Business of Life by Alice Schroeder|
Buy new: $14.00 / Used from: $8.87
Usually ships in 24 hours
Kindle 2/Kindle DX: Amazon's New Wireless Reading Devices (Latest Generation)