You Can't Pay Credit Without Paying Buffett

Cash or credit? Warren Buffett is betting you'll pay credit.

If you look at Berkshire Hathaway's (NYSE: BRK-B  ) latest 13F filing, you'll see three credit companies listed: American Express (NYSE: AXP  ) , MasterCard (NYSE: MA  ) , and Visa (NYSE: V  ) . American Express is by far the largest holding of the three, but the presence of the card trinity in Berkshire's holdings suggests that like Visa, Berkshire is everywhere you want to be.

It's worth considering why anybody would want exposure to multiple companies in the same industry. Why wouldn't you just pick the best and run with it? The first and most obvious reason is that the industry is poised to grow. According to MasterCard CEO Ajay Banga, roughly 85% of the world's retail transactions are conducted with cash or check, so there is tremendous market opportunity for these companies. Furthermore, each company is solid in its own right. American Express, MasterCard, and Visa all benefit from network effects; the more places accept them, the more valuable the service is to the cardholder. Network effects are one of the four sustainable competitive advantages across industries, so each company possesses the structural characteristics of a strong economic moat.

While the companies compete against each other, their services aren't mutually exclusive. Many consumers carry multiple credit cards, either for optionality or to fuel a spending habit. Therefore it's not unreasonable to assume multiple credit companies can continue to exist in the same wallet. American Express, MasterCard, and Visa control more than 90% of the market by purchase volume, so owning all three gives you good exposure to the industry's growth.

Past performance offers no future guarantees, but MasterCard and Visa have returned well since their IPOs and American Express has been a great investment for Buffett since he first bought shares in 1964. Here's a look at the return of the top four companies by purchase volume over the past five years versus the S&P 500:

As you can see, the returns trump the S&P, though it would have helped to own Discover Financial Services as well.

If 4 R.R.s are owned ... pay $200
There are other areas we could employ this strategy. We're looking for concentrated industries with good long-term prospects and companies that possess strong competitive advantages whose products or services are not mutually exclusive. Remember Monopoly? A classic strategy was to own all the railroads, because while owning one was great, having all four was even better. It turns out, reality is not so different.

The U.S. freight rail industry is dominated by four superpowers that control more than 90% of the market: CSX and Norfolk Southern in the east, and Union Pacific and Burlington Northern Santa Fe (fully owned by Buffett through Berkshire) in the west. The future of the U.S. freight industry is tied to the growth of the country. More people mean more goods transported, and the freight industry is well positioned, as it's more fuel-efficient than trucking. A freight train can move one ton of freight over 450 miles on a single gallon of fuel. The fuel efficiency of freight was one of Buffett's primary reasons for completing his stake in BNSF.

Freight rail companies possess strong competitive advantages. The heavy capital investment required to build railroads discourages competition, and regulations prevent railroads from being built side by side. Freight rail companies are not mutually exclusive, either. There are lots of goods that need to be transported from different places across the country. A map of freight rail lines shows the companies already coexist:

 

If we look at the returns of CSX, Norfolk Southern, and Union Pacific (excluding BNSF because it's now owned by Berkshire) over the past 10 years, we see comparable price movements, though Union Pacific in the west certainly fared much better:

Buying the key players in a concentrated industry is more focused than an ETF and keeps you from having positions in industry laggards. There's a Buffett-like simplicity in the approach, and it also allows you to weight positions according to your convictions rather than accepting an ETF's allocation. When evaluating an investment, Buffett always ask himself a simple question: Are more people going to be using or buying this good or service in the future? When it comes to credit card payments and freight rail, I'm guessing he would say yes.

While there are many investing strategies, Buffett's approach has always proved the best. He chooses great companies and sticks with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.


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  • Report this Comment On August 03, 2013, at 11:11 PM, d2mccarthy wrote:

    I have a problem with this article. How can you state buying all industries listed and not mention KSU? Cherry picking the dates of March of '09 to present KSU traveled the road from $12.52 to $110.06. You do the math. Looking at the the project to get a Mexican spur into Lazaro Cardenas deep water port (75 ft) allows $45,000 Longshoremen to unload COMPLETELY loaded ships of vehicles,etc. from Asia while San Pedro longshoremen make $200,000 unloading ships that are 75% loaded due to shallow depths of the port. Now we have Toyota and Honda building plants in Mexico and what rail line runs north from Panama to Bakken? Why it is KSU. Warren bot the wrong Railroad. IMHO This kind of poor info is the reason I dumped my subscription to your fine effort, fellas ! d2 mccarthy circa 8/13

  • Report this Comment On August 04, 2013, at 11:22 AM, XMFKAL wrote:

    @d2mccarthy

    Thanks for the feedback. I have several points of response though. The primary purpose of the article was not to declare an exhaustive buy-list but rather to provide a framework that could be used to identify a handful of companies in forward-looking industries. Perhaps I should have placed greater emphasis on the following sentence:

    <<We're looking for concentrated industries with good long-term prospects and companies that possess strong competitive advantages whose products or services are not mutually exclusive.>>

    Applying this logic to the freight rail industry certainly does not rule out KSU. I simply chose to discuss the four largest players in the industry because between them they split over 90% of the freight rail market. But as we saw with Discover, smaller players can realize significant growth if they manage to capture even a small chunk of that market share. So you are right in that there is definitely something to be said for maintaining awareness of initially smaller companies in these types of industries.

    You state that Warren bought the wrong railroad. Yes, but only if we are speaking in terms of absolutes. Buffett's stated goal is to provide returns for Berkshire shareholders in excess of what they could achieve in a market-tracking index fund. Buffett's holding period for BNSF is still relatively low compared to his other investments, but I would be willing to bet he won't lose sleep over his choice of railroad so long as BNSF performs according to his stated goal.

    Finally, I like your point about KSU running from Panama to Bakken. I was not aware of this but I will have to check it out. But while we are speaking of Panama, think about what the canal expansion will do for east-coast shipping. And which companies will be there to transport east-coast shipments? CSX and Norfolk Southern.

    Thanks again for your points and Fool on.

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