Is Warren Buffett Wrong About Oil Stocks? By John Manfreda

Recently, Warren Buffett has made headlines by selling all of his shares in Exxon Mobil, the rest of his position in ConocoPhillips, and reducing his stake in National Oilwell Varco. This has people wondering if the glory days of oil investing are over.

Warren’s opinion of oil investments carries a lot of weight, because over a 32 year period, Warren Buffet’s Berkshire Hathaway portfolio has generated an average annual return of 24%. His most famous investments are Coke, American Express, and Gillette (which is now Proctor and Gamble). These investments have made him over 3 billion dollars each. This is why when Buffett buys or sells a stock, everyone takes notice.

His first foray into the resource sector began in 2002, when he took a $500 million dollar stake in Petro China. In 2007, he sold it at a profit of $3.5 billion dollars. His next venture into the resource sector began in 2008, when he purchased shares in ConocoPhillips. This investment was made because Buffett claimed that the energy sector provided him the product stability. This investment ended up costing Berkshire Hathaway several billion dollars. The first reason this investment failed was he broke his own rule; and that is “if you can’t understand it, don’t do it.”

Buffett’s most successful oil investment was his railroad company Burlington Northern Railroad. This is considered an oil investment, because this rail road company transported oil from the Bakken to its refiners. Since 2009, Berkshire has collected more than $15 billion dollars in dividends from Burlington Northern Railroad, while its annual revenues have increased by 57%, and its earnings have more than doubled. The main reason his investment in Burlington Northern Railroad was successful, was due to the fact that he made this investment during the 2008 crisis, when prices were low. This Buffett quote explains the success of this investment perfectly, “Be greedy when others are fearful and fearful when others are greedy.”

In order for Buffett to buy a stock, the company has to pass this set of criteria: high margins with a low amount of debt (it doesn’t take a genius to run them); strong franchises and freedom to price, with predictable earnings. This set of criteria sounds great when investing in a consumer goods business, but when investing in the resource sector, it’s almost impossible to achieve. Look at this chart below.

The energy industry has higher capital spending requirements than other industries. To be successful in the resource industry, you have to readjust your investing strategy so you’re able to succeed in a high capital spending environment. This also means you have to be comfortable with companies possessing higher amounts of debt and lower margins than what you are normally accustomed to.