Warren Buffett and the Railroads

Warren Buffett has invested in three major railroads recently. This after the stocks had already run up quite a bit in the good economy we’ve had over the last several years.

Buffett built his fortune by being a “value hunter”. He typically buys companies that seem cheap to him based on earnings and cash flow. He must think the railroads are cheap, even though the stock prices are up significantly over the past several years.

The railroads are a classic example of a cyclical business. When economic times are good, they make a lot of money. In recessions and economic downturns, they often lose money.

Railroads have never seemed to me to be a good long-term investment. I have bought the stocks in bad times and made money as economic conditions improved. Generally when the stocks are high, the economy is going good, and might be ready for a downturn. When the downturn comes, railroad earnings plummet, the stocks go down, and the process repeats itself.

With Buffett’s long-term orientation, it is hard to understand what he sees in the rails in good economic times. One blogger recently speculated that it is because for the railroads, their return on capital exceeds their cost of capital for the first time in decades. That is good, but their return on capital will certainly go down in any economic downturn. Right now, things seem pretty rosy for the rails. But the good times come and go. They always have, and they always will.

Buffett is probably the greatest investor of all time, and one ignores him at his own peril. But, as someone who has traded railroad stocks and followed the industry for many years, I don’t see the railroads as being a “buy” right now.

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