Q: Are shares of Berkshire Hathaway B (BRKB) a good investment now that Warren Buffett's company is buying Burlington Northern Santa Fe (BNI)?
A: Warren Buffett is best known for owning companies whose businesses range from insurance to candy and ice cream. But railroads are quickly becoming one of the industries critical to the success of Berkshire Hathaway.
Buffett's interest in rails isn't new. Back in 2007, Berkshire Hathaway bought 10.9% of Burlington Northern Santa Fe. Now, he wants to buy the rest of the railroad, as you can read here.
Clearly, Buffett's biggest deal ever is a symbol of his bullishness on the railroad industry. And given Buffett's track record finding lucrative investments, investors are certainly intrigued.
But just because Buffett is making Berkshire's biggest bet ever, should you bet on Berkshire Hathaway Class B shares?
To find out, I'll put the stock through the four tests we consider at Ask Matt:
Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Berkshire Hathaway Class B's trading history back to 1996, we see the company generated an average annual compound rate of return of 9.0%. That is an outstanding return if you consider the Standard & Poor's 500's comparable return was 4.4%, says IFA.com.
To get that return, which beat the S&P 500 by 104%, you accepted moderate risk — standard deviation — of 24 percentage points. That's 45% greater than the S&P 500's long-term risk. But Berkshire has been able to generate returns high enough to compensate for the higher risk.
Berkshire is one of the few stocks to pass this tough test. But that's where the bullish case ends, as you will see as you read further.
Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When we run Berkshire's stock, we find it's rated "neutral." In other words, the current stock price is roughly equal to what the company is expected to generate in cash over its lifetime. Using this analysis, it would appear Berkshire stock is fairly priced: not cheap, but not expensive, either.
Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. If the company delivers 5% annual growth, as analysts are forecasting, the stock is in the "sell" range according to the Stock Selection Guide. Even if Berkshire Hathaway grows at twice that rate, it would still be in the "sell" range. This is a red light for investors who believe the stock's valuation will remain close to historical averages.
Step 4: Check the company's financial health. Before investing in any company, you want to make sure it's in good financial shape. A quick way to check is to look at where it falls on the USA TODAY Stock Meter, which ranks stocks from conservative (1) to aggressive (5). Berkshire scores a middling 3.3 here. Credit rating agencies, meanwhile, continue to give Berkshire some of the highest ratings possible, although those ratings may be downgraded following the railroad acquisition. You can get a Stock Meter score for almost any stock by going to money.usatoday.com and putting the stock's ticker symbol or company name into the Get a Quote box.
The bottom line: You can do much worse than investing with Warren Buffett. His long-term track record at finding attractively priced assets is unrivaled. And the fact he's willing to make such a big bet on Burlington Northern is certainly a signal that he sees a giant opportunity.
But remember that Buffett is human and has difficultly beating the market's returns over time. For instance, this year, shares of Berkshire Hathaway Class B are up just 6.8%, lagging the 23% gain of the Standard & Poor's 500 and the 18% gain of the Dow. If you add in the S&P 500's 2% dividend (Berkshire pays no dividend), you can see that Buffett doesn't always beat the market.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column.Related Links
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