Buffett's Biggest Oil Play Ever

If you follow Warren Buffett closely, you may be scratching your head on this one.

After all, Buffett's last famous big oil deal was one of his few large investing missteps. In 2008, Buffett ramped up his stake in ConocoPhillips at exactly the wrong time. In his own words:  

I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year [2008].

And you probably haven't heard much about Buffett and oil since (except for him slowly reducing his stake in ConocoPhillips).

That's because Buffett's move was a stealth oil play. But it's a stealth play that's so big it can render any subpar returns he may generate on ConocoPhillips immaterial.

Let me explain the massive move he made and then explain how we can still follow his coattails today.

The play
A year and a half ago, he claimed the $44 billion acquisition of railroad Burlington Northern Santa Fe was "an all-in wager on the economic future of the United States."

That makes a lot of sense. Since railroads get paid to schlep raw and finished goods, they are a big part of the circulatory system of a healthy economy. Healthier consumer demand leads to fatter top and bottom lines.

Still, on the surface, Buffett was still paying a 30% premium for a 19th century business during uncertain economic times. Underneath the surface, though, Buffett masterfully locked in a huge play on rising oil prices when prices were around $70 a barrel.

He explained the advantage clearly in his recent shareholder letter:

Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That's three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs.

When he explains it like that, it doesn't take a Buffett-sized brain to see how that 3:1 relative fuel efficiency advantage of railroads over trucking is powerful as oil prices rise.   

How you can play this advantage
Now, obviously we can't buy Burlington Northern directly anymore. We can buy it through shares of Buffett's sprawling holding company, Berkshire Hathaway (NYSE: BRK-B), but if a pure railroad play is what you're after, there are still some choices that are selling for lower multiples than what Buffett paid for Burlington Northern.

Buffett paid almost three times tangible book value for Burlington Northern. Here's a list of the sizable railroads we can buy on major U.S. exchanges. I've sorted them from cheapest to most expensive.

Source: Capital IQ, a division of Standard & Poor's.

You'll notice that five of the railroads sell for price-to-tangible book values below three, including one in China -- Motley Fool Global Gains pick Guangshen Railway.

All of the other railroads on the list are based in either the U.S. or Canada and offer the potential to be our very own Burlington Northern.

Meanwhile, Guangshen is a way to participate in China's focus on building up its infrastructure. As Buffett's trusted Burlington Northern CEO Matthew Rose puts it:

You read a lot about China in terms of the investments they are making in airports, railroads and highways. They are rebuilding and expanding every mode of transportation over there ... so that they can be more efficient, which means that their foreign exports to places like the United States, Europe and the rest of the world will be better positioned to remain competitive as their labor costs rise over time.

The takeaway
I'm not one to take advice from Buffett lightly. In this case, he's done very well on his investment in Burlington Northern, and he's given us a clue to the possible fuel-efficiency advantage of railroads over trucking.

I'm adding these companies to my watchlist so that I can see if there's a good opportunity here (besides the Berkshire Hathaway shares I already own). If you'd like to start a free watchlist of your own, we'll keep you updated on your favorite companies and give you immediate access to a new special report, "Six Stocks to Watch from David and Tom Gardner." Click here to get started.