Buffett Shows Why He's 'The Wizard'

Question: Why Is Buffett The Wizard of Omaha?
Answer: (NYSE:BNI)

Analysis of Berkshire Hathaway's (NYSE:BRK.A) acquisition of Burlington Northern Santa Fe Corporation.

Value Expectations is often critical of silly corporate acquisitions, where bidders overpay to add growth or strategic opportunities. While those terms sound nice, the bottom line is that firms need to be able to justify the value of said growth or strategic opportunities with future cash flows. More often than not, firms bank on unreasonable growth or profit expectations to justify a deal. For recent examples, see our analysis of Kraft/Cadbury (KFT/CBY) or Dell/Perot (DELL/PER):

But sometimes, deals make sense for the buyer and the seller. Tuesday morning, Warren Buffett, The Wizard of Omaha, announced that his firm, Berkshire Hathaway, will acquire Burlington Northern Santa Fe for $100 a share, or a 31.5% premium to its $76 closing price Monday. This deal makes sense for current shareholders, who are receiving a great premium on their current share price and for Berkshire which is buying a great franchise at very reasonable future expectations.

Using our Value Expectations™ process, we can understand why Buffett has put together such a consistent long-term track record making investments. The table below summarizes BNI’s achieved sales growth and EBITDA margins, and the implied expectations Buffet is paying for in the $100 share price.

Source: www.ValueExpectations.com

While we do not have a 50 year track record like Mr. Buffett, we employ many of the same concepts Mr. Buffett has employed throughout his career, namely:

1. Identify management teams that create value 2. Identify situations where today’s price reflects reasonable expectations for future growth and profits 3. Identify companies with strong economic performance, not accounting.

We quantify those factors through the use of our – Management Quality Scores, Intrinsic Value Analysis (Value Scores), and expected changes in economic profitability levels (Economic Margins). The graph below displays the results of applying our process to US stocks since 1989 (check date).

AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns

Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms

Interestingly, the Toreador Large Cap Fund (TORLX), which also follows many of the above principles, agrees with Buffet as BNI is its largest holding in the transportation sector.

For a list of stocks meeting the VE criteria above, check back during the week as we put one together to salute the Wizard for leading by example again on how to make a smart acquisition.

Comments

[Mad Hedge F...:]

xcv You’ve got to hand it to Warren Buffett, who never does anything half heartedly. The stunning news that his Berkshire Hathaway (BRK/A) is paying $44 billion for the 73.4% of Burlington Northern Sante Fe (BNI) he doesn’t already own, a 30% premium, had punch drunk traders picking themselves off of the floor. The other rails rocketed, like Union Pacific (UNP), CSX (CSX), and Kansas City Southern (KCSR). The deal is the Oracle of Omaha’s largest in his career, and took the BNI board all of 15 minutes to approve. For me this deal speaks volumes about the long term trends in the US economy as seen by its greatest investor. It screams Commodities! Commodities! Commodities! Rails can only prosper moving bulk freight from the heartland to ports on the three coasts, which foreigners are buying in ever larger quantities at ever higher prices. It also says the coal industry isn’t going anywhere soon, as it accounts for 70% of all rail traffic, so you can kiss Cap & Trade goodbye. Buffet let loose of some fascinating statistics about the enormous productivity increases the industry has accomplished. In the last 25 years, it cut employment from 500,000 to 175,000, while increasing freight by 60% and reducing track by 40%, and now accounts for 40% of the total goods moved in the country. Railroads are the greenest transportation out there, a ton of freight requiring only a gallon of fuel to move 470 miles. When I was growing up, my big goal in life was to become a train engineer. Maybe it’s time for me to revisit that aspiration. And I promise not to text while driving!

Nov 04 06:33 AM