Bad companies and good investments...

One of the big news items of the week is Berkshire Hathaway's acquisition of a Burlington Northern, a large US railroad.
http://www.nytimes.com/2009/11/04/business/04deal.html
Since Berkshire Hathaway is Warren Buffett's brainchild, this has provided a platform for many analysts to read the tea leaves. Here is some of the spin that I have seen and what I think about the spin.

A significant number of the analysts have argued that Buffett is making a bet on the US economy recovering by making this investment. I find this puzzling at two levels. First, if you were going to make a bet on the US economy, railroads seem like a pretty poor choice. Unlike housing and consumer durables, railroads have not seen their earnings increase dramatically in good economic times. Second, Buffett has always expressed his skepticism about market timing and macro investing strategy and this investment would be a significant departure.

Here is my take on the investment. Railroads in the United States are the quintessential mature business. It is extremely unlikely that you will see much real growth in this business; constructing a new railroad or even adding new rail lines would have prohibitive costs in the US, given real estate costs and litigation issues. Companies in this business have earned returns on invested capital that have lagged the cost of capital for decades. Put another way, very few railroads would make the list of most glamorous companies or be featured in Tom Peter's list of excellent companies.

So, why would Buffett invest in a bad business? I have said some unfavorable things about Warren Buffett on this blog before. At the risk of repeating myself, I think he has been hypocritical on corporate governance and he plays the "I am just a hick from Omaha" role to perfection. However, I think his status as a great investor can be boiled down to his capacity to separate "great companies" from "great investments" . Put another way, Buffett has always recognized that a great company can be a terrible investment, if you pay too much for it, or that a mediocre company can be a great investment, at the right price.

Here is the bottom line. I don't think that Buffett's investment in Burlington Northern is a bet on the US economy or an expectation of a surge in profitability for railroads. I think it reflects a more prosaic choice. Buffett thinks he is getting a good deal for the company at the current price, and he has history on his side. The best investments in the market are often among the companies that are viewed as the least glamorous and most boring: Burlington Northern clearly fits the bill.