Warren Buffet recently acquired Burlington Northern Santa Fe Railroad (BSNF)
News Video: Warren Buffet Buys Burlington Northern, Bets on the U.S. Economy
It is a very good thing that the legendary investor Warren Buffet is giving me the chance just like Chess Masters did, when they showed the scores of game to us so that we can study the game and learn from them why a particular decision was taken and also get a chance to study their technique.
About Burlington Northern Santa Fe Railroad. (The company to be acquired)
This is the balance sheet buffet must have seen....
The Balance Sheet of BSNF(Burlington Northern Santa Fe)
The Diluted Earnings per share is a factor which is to be seen here for the growth of the company. In 2004 BSNF was having an EPS of $2.14, and in 2008, the same value is $6.08
According to the formula, the average growth rate i.e. the CAGR rate is 23.22%, which means BSNF in it's last 5 years has made an aggregate progress of 23.22% yearly.
You can find the formula for CAGR here...
Why Aggregate?
It also needs to be mentioned here upon studying the chart that buffet is not considering one year loss period which was there in 2007. So, he must have considered the Average growth. The reason being that latest reports may not reflect the true picture of company so reports of at least 10 years needs to be there with us, so that the aggregate growth can be computed to get a more fair picture.
Buffet's Deal Details
Now, it needs to be noted that for Buffet the growth rate of 23.22% in past earnings is sufficient. which means a satisfactory growth rate, and as Buffet looks atleast 10 years down the line then he can expect the company to grow more than 200% in 10 years.
Let me make this simple, buffet believes that in 1 year(this is just an example because buffet never thinks below 10 years) my $100 per share will be $123.22 per share plus the dividends i will get.
Let us also look in the chart for dividend payouts of this company.
The dividend in 2004 is $0.64 and is $1.44 in 2008, which means it also grows annually by 17.61%
If you look at the 5 year chart of Google Finance (http://www.google.com/finance?q=NYSE:BNI) you will also find that BNSF is very regular in giving dividend payments and gives dividends every quarter. (which is very important criteria for buffet)
So, buffet would expect that in one year he will get $123.22 + (1.44+0.25=1.69) = $124.91
Now, let us look at the price that he bought the BSNF. Is it a good deal in terms of valuation...
The price at which buffet bought the shares are at $100 per share and that too 77.4% of the total shares.
You can find the details of the deal here... http://www.dailyfinance.com/2009/11/03/buffett-takes-ride-on-the-bnsf-railroad-buys-burlington-norther/
If you see at the last EPS figure of $6.08 per share then buffet's P/E ratio to buy is
$100/$6.08 = 16.45 P/E Ratio (the multiple of the value of the company which market is willing to pay)
It should be noted that buffet may have bought some stocks before the announcement was made by him publicly but who knows that factor is present or not in this deal.
Before the deal was announced the shares were available at $75
The price was $75 when it closed the next day it opened at $97... still buffet wanted to buy the stock because the investment principles indicate that a P/E of 16.45 is still manageable.
The Deal after 10 years (the minimum holding period for Warren Buffet)
So, how much buffet can earn after 10 years with this deal?
As the EPS of the stock will increase by about 23.22%, then after 10 years i have computed that EPS of one share will be $49.08, which means if we keep the P/E ratio of 16.45 as intact then also the stock will earn and the fair price of the stock will be $807.20 per share.
Plus if we include the dividends each year then the sum of the dividend in each year amounts to $40.51 per share.
So, buffet's gain will be $807.20(Expected selling value) + $40.51 (Dividend earnings) - $100 (purchasing price)
$807.20+$40.51-$100 = $747.71 profit per share which was bought at $100!!
Is the Past Performance been done in that fashion?
Yes, if you see the same chart in google shows that the P/E of Santa FE has been around 16.54 for the last 5 years and Warren Buffet got this deal closed at 16.45.
Conclusions of this Deal
Buffet is a great believer of the American Economy, now he is also one of the RailRoad Tycoons of USA. He believes that the US Economy will gain and there would be a very heavy transport need for RailRoads.
Main Points are
1) It is a solid Frachise business.
2) It is a value deal and not expensive.
3) Company's growth is also good.
4) The Dividends are regular
5) Ignore Short Term Market Sentiment (See Current Year Section below)
My only concern is that the P/E of 16.45 is nearer to P/E of 20, so his margin of safety principle is little exercised here.
However, He also believes that in coming days, the transportation of goods would be more preferred by Railroads which may mean that other means of transportation needs Oil (like Airplanes,Roads) and he may be believing that oil based transportation may be very costly in near future because
1) Oil rates will rise 2) Dollar is going to fall 3) USA's Relationships with the Middle East
So, in this scenario Rail Roads are surely a better option.
More details of this deal conclusions can be found in the below video
The Current Year
In Current Year the aggregrate of 3 quarters adjusted to 4th quarter and according to that estimate the EPS of Current Year is $4.61, which means a loss in EPS of around 25%, but it should be seen that inspite of this Buffet is going for the deal. He is not looking for only the near future or current year, he has a long term view of the prospect of the company (as discussed earlier that this company also faced loss in 2007 as given in graph). What matters to buffet is the performance in the long term.
Readers, I am sure that you will also buy stock in the same manner as described here.
Regards,
Mahernoz Daruwala
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