Dear Friend,
Just how significant is Warren Buffett’s $26 billion investment – announced earlier this week – in Texas-based railroad Burlington Northern Santa Fe?
Believe me…it’s much more than just an investment made – as Buffett joked – because his “father didn’t buy me a train set as a kid.”
After all, this deal is the biggest acquisition ever for Berkshire Hathaway.
In the wake of this enormous transaction, Buffett told CNBC that his move was “a bet on the country.” He added: “I believe this country will prosper and will have more people moving more goods 10 to 30 years from now and the rails should benefit.”
On the surface, Buffett’s transaction is precisely that: an investment that will pay off over the long haul should America prosper.
But if you look at the transaction a little more closely, you’ll see that Buffett has, once again, sent a clear signal to investors like you and I.
Are You a Speculator or an Investor?
Ben Graham wrote that the major distinction “between the investor and the speculator is their attitude toward stock market movements.” He said that the speculator’s primary goal is to profit from stock market fluctuations, while the investor looks to acquire pieces of companies (stocks) at attractive prices.
If you watch the day-to-day fluctuations of the stock market – and you become giddy when prices rise and gloomy when they fall – then you need to come to terms with the fact that you are a speculator.
If price fluctuations, either up or down, don’t faze you – or you rarely look at your monthly brokerage statement – odds are you are an investor.
You realize that over the long term, the price of the stock will accurately reflect the worth of the underlying business and not the day-to-day gyrations of the stock market.
Clearly, Warren Buffett is an investor – arguably the most successful investor of all time. And during times of extreme pessimism – like right now – the stock market offers investors like Warren Buffett a big advantage. That’s why it’s so important that we follow his lead…
Advantage: Long-Term Investors
Under normal circumstances, you can expect most stocks to trade at or around their fair value, reflecting the fundamentals of the underlying businesses. In that environment, undervalued stocks are few and far between.
When those periods occur, great value investors do nothing. Warren Buffett wrote that he loves to own stocks – but only if they can be purchased at attractive prices.
If he doesn’t think that there is a very high probability of getting at least 10% pre-tax returns on his investment…he’ll simply sit on the sidelines. Buffett concedes that sitting on the sidelines is no fun, especially when short-term money market rates earn him less than 1% after tax. But he is also careful to point out that “occasionally, successful investing requires inactivity.”
However, during periods of extreme pessimism, long-term investors have a big advantage.
When pessimism is the order of the day, the stock market offers investors the chance to buy pieces of companies (stocks) at prices that are much lower than the underlying worth of the business.
This is the type of environment we are in now. When volatility picks up in the market, it is the time to smile, not frown. Why? As Buffett says, “Because a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.”
So by announcing a $26 billion investment – in addition to the $8 billion stake he already owned – in Burlington Northern, Warren Buffett was sending an unmistakable message:
He feels that Burlington Northern is a solid business that happens to have an irrationally low price…thanks to the overall pessimism about the economy.
After careful analysis, Buffett decided to take advantage of that opportunity…in a big way. And a transaction like that – the largest ever by one of the world’s most successful investors – demands our attention. So let’s look at it another way…
Eating Hamburgers
The mere fact that you’re reading this e-zine tells me that you expect to be a net buyer of stocks over the next five to 10 years (just as I do). And if that’s the case…a drop in stock prices ought to have you smiling, not depressed.
Those who don’t share this analysis are looking at things from the wrong angle. But don’t take my word for it – this is what Warren Buffett himself wrote on the subject:
“This is the one thing I can never understand. To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the Hallelujah Chorus in the Buffett household. When hamburgers go up, we weep. For most people, it’s the same way with everything in life they will be buying – except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”
Value investors – among whom I count myself – recognize that a stock is an ownership interest in a business, and, all other things equal, we prefer to pay a lower price for it.
In addition, we focus on businesses with attractive economics, a defensible franchise and capable management – characteristics that put such companies at an advantage in the current business environment.
Warren Buffett’s $26 Billion “Bet on America” is a
Perfect Example of How to Execute this Sound Strategy
A stock’s price can and will be disconnected from the underlying worth of the business for extended periods of time and for a whole host of reasons.
The current economic climate, Buffett suspects, has disconnected the price of Burlington Northern from its value. So he jumped at the chance to take advantage.
However, over the long term, the stock price will track the value (both higher and lower) of the underlying business. That is why you should spend your time monitoring the change in the worth of the business instead of the stock price.
During times of fear, when stock prices trade much lower than the underlying worth of the business, is the time you want to be a buyer, not a seller.
When Buffett was asked the secret to making money in the stock market he replied, “We simply attempt to be fearful when others are greedy and greedy only when others are fearful.”
Buffett’s $26 billion investment in Burlington Northern is as clear a signal as you’ll ever get: Now is the time to be greedy.
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Warren Buffett’s message is one we should all take very seriously.
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Sincerely,
Charles Mizrahi, Editor
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