What in the World Is Warren Buffett Thinking?

Warren Buffett's done it again.

On Monday, Buffett's Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) upset Wall Street's apple cart with a $9 billion bid to buy Lubrizol (NYSE: LZ  ) . Caught by surprise, the Street sent the chemical concern's stock rocketing 27% higher. And while I've developed a reputation as a Buffett skeptic, this time I agree with his move.

When the Oracle of Omaha decided to buy Burlington Northern a couple years ago, I questioned the wisdom of the move, and even suggested that the master investor was passing up real value investments in the interest of preserving his legacy. But Buffett's decision to purchase Lubrizol makes a whole lot more sense than his investment in Burlington.

Valuation matters
Two years ago, around about the same time Buffett was buying Burlington, I spotlighted Lubrizol as a potential bargain for long-term investors:

"Over the past five years, Lubrizol generated average annual free cash flow … more than 50% greater than its reported "profit" under GAAP. … [S]elling now for just 13 times its free cash, the stock looks fairly priced for its growth prospects…"

Granted, Buffett wasn't quick enough to grab Lubrizol at that low price. (In his defense, he was otherwise occupied at the time.) But even today, Buffett is getting a pretty square deal for Lubrizol. At $9 billion, he's paying 12.2 times earnings for the company, a fair price relative to the 16 multiple at DuPont (NYSE: DD  ) , and the 21-times-earnings valuation at Dow Chemical (NYSE: DOW  ) . Lubrizol's free cash flows don't entirely support its GAAP numbers, true. But even at 17.5 times FCF, Buffett's bid seems fair relative to Lubrizol's projected 15% long-term growth, and its 1.4% dividend yield.

What's it mean to investors?
Post-run-up, Lubrizol's share price today is fair. There's not much more value to be gained here by trying to hitch a ride on Buffett's coattails -- but that doesn't mean there aren't other values to investigate. In fact, just recently I wrote about a smaller specialty chemicals maker by the name of Innospec (Nasdaq: IOSP  ) . With a market cap of less than $700 million, it's probably too small to "move the needle" for Berkshire, but it could still do wonders for your portfolio.

If you like the look of this potential mini-Lubrizol, add Innospec to your watchlist.