Is It Time to Buy the Buffett Stock That Buffett Can't Buy?

In 2010, Warren Buffett’s Berkshire Hathaway (BRK.A -0.36%) (BRK.B -0.30%) made its biggest acquisition in its history at the time, acquiring the railroad Burlington Northern Santa Fe (BNSF).

The move surprised Buffett watchers, as it was Berkshire’s first foray into the railroad sector. Buffett acted opportunistically, making the bulk of the purchase in 2009, during the depths of the financial crisis while the stock was down.

However, looking at Berkshire’s investment in BNSF, which paid off handsomely, it fits with the classic Buffett approach. Railroads like BNSF enjoy high barriers to entry thanks to the massive capital costs involved in operating one, and the industry has become a well-defined oligopoly at this point. There are no start-up railroads.

They’re also an essential component of the economy, moving goods like oil, wheat, chemicals, and other materials. In fact, they’re so essential that Congress just brokered a deal between the railroads and unions to avoid a strike. Railroads are also more efficient than competing modes of transportation, like trucking, making it difficult to disrupt them with a different shipping method.

If you want to be like Buffett and invest in a railroad, there’s a better way to do it than buying Berkshire shares to get exposure to BNSF. You can buy its close competitor, Union Pacific (UNP 0.68%).

Two workers fixing a railroad signal.

Image source: Union Pacific.

What is Union Pacific?

Union Pacific is the nation’s largest railroad, covering 23 states in the Western two-thirds of the country. Along with BNSF, it’s part of the railroad duopoly in that half of the country, which has enabled both of them to earn huge profit margins.

Union Pacific is also one of the oldest publicly traded companies in the country, founded in 1862, and it has been paying a dividend for an incredible 123 consecutive years. Currently, it offers a dividend yield of 2.6%.

The economics of the railroad industry and the duopoly with BNSF mean that Union Pacific is highly profitable, with an operating margin that hovers around 40%, a sign that its services are in high demand, and well ahead of the costs to run the railroad.

What would Buffett do?

Much like BNSF, Union Pacific seems to have all of the hallmarks of a Buffett stock. It has a wide economic moat and a long operating history. It’s a dividend payer, and it generates predictable cash flows. In fact, Union Pacific even outlined its capital allocation plans for 2023 in its recent earnings report, saying it plans to spend less than 15% of revenue on capital expenditures, targeting $3.6 billion; pay 45% of its profits out as dividends; and use the remaining cash for share repurchases. That, in combination with its strong position in the railroad industry, has been a winning strategy for Union Pacific. 

Unfortunately, though Buffett may want to own Union Pacific stock, he can’t. For Berkshire to own it outright would constitute a monopoly, and buying shares of a competitor to one of Berkshire’s subsidiaries would be a conflict of interest.

However, as an individual investor, you’re not subject to those constraints. You can take a similar approach to Union Pacific as Buffett did with BNSF. Much like Buffett acquired BNSF when the stock was down during a recession, the current economy could present a similar opportunity for Union Pacific because the railroad industry is cyclical.

The stock fell 5% in the two sessions following its recent earnings report after the company missed estimates on the top and bottom lines, and its guidance called for essentially flat volume growth in 2023 due to economic headwinds. However, it still expects to gain market share, raise prices to offset inflation, and improve operating margin.

Union Pacific seems like a great stock to buy on weakness, as it could dip even lower if the economy heads toward a recession. 

Over the last decade, Union Pacific has almost always traded above a price-to-earnings ratio of 16. With the current P/E just below 18, this classic Buffett-style stock is getting close to a being no-brainer buy.

Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway and Union Pacific. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway, short January 2023 $200 puts on Berkshire Hathaway, and short January 2023 $265 calls on Berkshire Hathaway. The Motley Fool has a disclosure policy.