Buffett, Railroads, and the Lessons of History

Guest columnist Alice Schroeder is author of The Snowball: Warren Buffett and the Business of Life. Schroeder is a noted insurance industry analyst and writer who was a managing director at Morgan Stanley.

Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) deal to buy Burlington Northern Santa Fe (NYSE: BNI  ) isn't the first time Buffett has invested in one of his lifelong interests. His first childhood business was selling chewing gum, and he put money into Wrigley last year. His second was selling Coca-Cola (NYSE: KO  ) , and Berkshire Hathaway owns 200 million shares of that company today. Buffett's relationship with the bank Goldman Sachs (NYSE: GS  ) , another investment, began when his father took him to meet the firm's chairman on a 10th birthday trip to New York City.

Does Buffett actually invest out of nostalgia?
Certainly, he's a sentimental guy who's fond of the tokens of his past. He's also frequently discussed the importance of a rational temperament in investing. What, then, is the logic behind his choice to so often invest in businesses that predate his own father and even his grandfather?

Let's take railroads as an example. When Buffett was a little boy, he had only a small, single-oval train set and used to "drool" every year over the huge, multi-engine railroad diorama that the Brandeis Department Store set up in the toy department every Christmas. One of the fondest memories of his childhood was being taken to Chicago on a train by his grandfather to see a Cubs game.

Buffett's hometown of Omaha was dominated by the railroad business; trains became inescapably paired with finance in his mind at an early age. Buffett, as a boy, read biographies of early tycoons like Cornelius Vanderbilt, James Fisk, and Jay Gould, men who fought ferociously to control the Erie Railroad's stock.

Another financier who interested Buffett, Jay Cooke, pioneered modern investment banking and financed the Civil War debt of the Union government. Cooke was bankrupted by his obsession to build the Northern Pacific Railway. Buffett also became fascinated by the battle between E.H. Harriman and J.P. Morgan to corner Northern Pacific's stock, which caused the market panic of 1901 and is considered the greatest short-seller squeeze in history.

A lifelong student
Studying stories like this is one way Buffett has spent a lifetime scraping with his mental lint brush to pick up every tiny fleck of knowledge about any industry that attracts him. These are invariably the basic products and services that many people would find boring, yet to Buffett they are not numbers on a page, but exciting stories out of history peopled by lively characters who are engaged in battles of will and struggles to prevail against powerful economic forces through cycles of innovation, capital creation, and destruction.

This kind of learning is one means through which Buffett worked out the larger lessons of the railroad business, which began as a thrilling new technology that connected disparate parts of the world, evolved into a network of profitable monopolies, then fell out of favor as cheap oil and regulators put a lid on pricing power.

When Buffett considered investing in electric and water utilities, the history of railroads was a point of comparison that helped frame the decision in his head. When he invested in energy and commodity stocks, his deep knowledge of railroad economics helped him better understand energy distribution. All along, Buffett had been studying utilities and the energy businesses as well, so when he bought an electric utility and two pipelines for Berkshire, that taught him even more about railroads.

A simple lesson from railroads
For a long time, Buffett had invested in railroads only when they were cigar butts. Then they were deregulated, energy costs began to rise, and railroads became profitable once again. Berkshire first announced that it owned 10% of Burlington in April 2007.

Buffett has always said that if he likes a company well enough to own its stock, it means he likes it well enough to buy the whole thing. Eighteen months after the first announcement, that's just what he did. It's interesting that even with an 18-month head start, the rest of us have been scrambling since the announcement to catch up with the many factors that influenced his decision.

One of the best and simplest lessons that can be learned from Warren Buffett is to learn things before you need the knowledge. This, after all, is why Buffett invests so often in the businesses he's had the most time to study.

Guest contributor Alice Schroeder's biography of Warren Buffett, The Snowball, was just released in paperback. She is a shareholder of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway, which is a Stock Advisor and an Inside Value recommendation. Coca-Cola is an Inside Value and an Income Investor recommendation. The Fool has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (91)

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  • Report this Comment On November 19, 2009, at 3:02 PM, scjordan31 wrote:

    I would submit Buffett also studied Anschutz and what he used his railroad holdings for.

  • Report this Comment On November 19, 2009, at 8:30 PM, SwampBull wrote:

    Thank you for your perspective, Ms. Schroeder. Buffett's story continues to inspire awe among the financial community, despite the fact that his investment characteristics are very unsurprising to those who know his background. Buffett believes in the continued prosperity of America, the continued decrease in value of the dollar and other currencies, the lack of a good reason for owning gold as opposed to equities and bonds.

    On a side note, you mention that his first stake in Burlington was in April 2007, yet you state he purchased the whole thing 18 months later. Was the purchase in 2008, and disclosed a year later, or does the math not add up? 30 months have elapsed from April 2007 to October 2009. Though, I would understand if you still felt like it was 2008 - many of us do.

    Best regards,

    CJD

  • Report this Comment On November 19, 2009, at 10:36 PM, TMFMmbop wrote:

    "learn things before you need the knowledge"

    A valuable insight. I enjoyed the article.

    Tim Hanson

  • Report this Comment On November 20, 2009, at 1:36 AM, thisislabor wrote:

    I don't know if you can make that extension and call it logical.

    it would be better to say, "learn things that you already have basis to learn off of".

    I mean, I'm just analyzing it and it appears more to me that he added to his knowledge stuff that he already some what of a base in//knew about. Instead of just deciding to learn random things in hopes that he would be able to use it some day.

  • Report this Comment On November 20, 2009, at 8:58 AM, Rodewarrior wrote:

    Article was Great! This reminds me of Peter Lynch's book "Beating The Street". The bottom line.....BUY WHAT YOU KNOW! If your in Banking buy Bank stocks, if your in Manufacturing buy Manufacturing etc, etc, You know who the competition is, the up and comers, the sliders,......This is free and legal Inside information!!!!

  • Report this Comment On November 20, 2009, at 5:23 PM, aliceschroeder wrote:

    Hey this is Alice with some thoughts on the trading. Between April 07 and April 08 after BRK's position in BNI was revealed, Warren was still building up his huge position and the stock was flying. Yes, you you could have bought then but you were chasing him at prices above what he had been paying. Starting in 2Q08, the price started dropping fast, & the window opened. A few months later it was revealed that he was selling BNI puts @$80. This was described as putting a floor on the stock, and was it ever.

    As an aside you have to wonder if this is part of why he waited until Fall 09 to buy it. If I were his lawyer last spring I would have said, Gee, Warren, some people might complain if you bought the company for $100 within a year after you sold them puts at $80. Why don't you wait awhile.

  • Report this Comment On November 20, 2009, at 6:35 PM, SwampBull wrote:

    Interesting stuff - thank you for the follow-up.

  • Report this Comment On November 21, 2009, at 11:10 PM, radass wrote:

    What is Buffett's secret to having so many billions in equity? The answer: His auto insurance business. Something that is always overlooked.

    There have been some asset managers that have done better than the Man himself, but not many did it with their won money so as to not acquire as much wealth as Buffett.

    However, Buffett has Geico, one of the largest auto insurers in the United States, a country that has by far the largest auto insurance market in the world. As far as I know, all 50 states requires auto insurance with the ownership of a motor vehicle. The average American is likely to own a motor vehicle than own a home, a life insurance policy, or have health insurance. And with the relatively low overhead of the auto insurance business, one can imagine the amount of cash flow coming into a large scale business as this.

    He then just wisely invests into undervalued entities with large margins of safety and waits it out. He invests for long-term strategic reasons.

    It was his insurance business, particularly auto insurance, that that really got him where he is now thanks to his vision. And now, ironically, he's putting himself fully into the railroad business. Another visionary move, the 100% purchase of BNI. With the predictable strategic high price of energy and the growth of the areas west of the Mississippi River, BNI will grow in value. There will be a railroad industry revival in the U.S. not seen since the early 20th century.

  • Report this Comment On November 24, 2009, at 9:07 AM, jfenlon wrote:

    Rodewarrior please have someone edit your messages for grammar. The word "your" is a possessive denoting ownership. The word "you're" is a contraction of the words "you are" and reflect the meaning intended in your statement. You lose credibility when such elementary errors are present.

  • Report this Comment On November 24, 2009, at 3:53 PM, jaderdavila wrote:

    the story of when he was kid was nice

    but i think the raw fact is that

    in this visit the chinese must have told obama

    that they want los angeles for a hub

    it's so nice when you have a railroad

    starting from LA to anywhere

  • Report this Comment On November 26, 2009, at 11:46 PM, topsecret09 wrote:

    Very good article. Short and to the point.... TS

  • Report this Comment On November 27, 2009, at 6:10 PM, watcherbob wrote:

    has warren ever made a blunder ? not too many investors can claim a perfect track record, but aside from that he is the very best

    how could anyone go wrong holding coca cola?

  • Report this Comment On November 28, 2009, at 1:23 AM, CADBRKA2001 wrote:

    Not surprising at all. Buffett needs the transportation capacity to move all the stuff his other companies are buying, sellling & producing (like shoes, underwear & candy). BNSF is one more piece of the BRK picture along with X-tra and McLane, the other transport businesses in the Berkshire family. This purchase is in line with the acquisition criteria found in the Annual Reports-especially on the aspects of getting a good value, management we can trust & the little or no debt provisions.

    Monopoly ? Maybe.

    Farsighted ? Probably.

    Smart ? Only time will tell.

    Next May's Annual Meeting will be really interesting !

    Thanks, Alice for an insightful article & great book.

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