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.