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Why Buy a Railroad? Buffett's Simple Genius

By    |   Thursday, 05 Nov 2009 08:20 AM

Warren Buffett bought all the shares of Burlington Northern Santa Fe that he didn’t already own for $100 a share. The stock was trading near $76 before his announcement, so we can learn a great deal about what Buffett likes in a company by studying this stock for a few moments.

The price-to-earnings ratio is about 18. It is the same based on trailing earnings or estimates. Earnings are expected to grow by about 10 percent a year for the next five years.

This demonstrates that Buffett isn’t looking for strong growth numbers. There are many stocks with faster growth and higher projections. The problem with rapid growth is that it is usually unsustainable. Buffett is like the hare in that old fairy tale, “The Tortoise and the Hare.” Slow and steady wins the race.

Burlington Northern’s earnings growth is below average among railroads. But it is steady. That five-year growth rate closely mirrors the actual performance of the past five years. That indicates good management.

Buffett’s favorite tool to measure management is return on equity. This shows how much money the management makes relative to the size of the company. It provides a quick way to compare big companies to small companies, and puts all companies in an industry on an even footing.

Here, we see that Burlington Northern is among the leaders. It has a relatively high return on equity, and that number is fairly steady from year to year. Again, stability is important to Buffett.

He is also looking for value, and that is found in cash. This company generated more than $3.3 billion in cash last year. Price-to-cash flow measures the price of a stock to how much cash it generates.

Buffett paid a price that is equivalent to less than 10 times cash flow. This is in line with the historic average for Burlington Northern.

Buffett spotted a bargain. The company is selling at a discount on cash flow and has good management. This is what he looks for, and individuals can also profit from this ide

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Warren Buffett bought all the shares of Burlington Northern Santa Fe that he didn’t already own for $100 a share. The stock was trading near $76 before his announcement, so we can learn a great deal about what Buffett likes in a company by studying this stock for a few...
warren,buffett
352
2009-20-05
Thursday, 05 Nov 2009 08:20 AM
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