Is Warren Buffett wrong about oil stocks?

April 6, 2015 10:10 AM

Recently, Warren Buffett has made headlines by selling all of his shares in Exxon Mobil, the rest of his position in ConocoPhillips, and reducing his stake in National Oilwell Varco. This has people wondering if the glory days of oil investing are over. 

Warren's opinion of oil investments carries a lot of weight, because over a 32 year period, Warren Buffet's Berkshire Hathaway portfolio has generated an average annual return of 24%. His most famous investments are Coke, American Express, and Gillette (which is now Proctor and Gamble). These investments have made him over $3 billion each. This is why when Buffett buys or sells a stock, everyone takes notice. The problem with this generally accepted assumption is that it hasn't been proven that his equity investing success equates to success in the resource sector. In order to find out if this accepted assumption is correct, we first have to visit Warren's history of investing in the resource sector. 

His first foray into the resource sector began in 2002, when he took a $500 million stake in Petro China. In 2007, he sold it at a profit of $3.5 billion. This investment was successful because he bought it when it was undervalued. He thought the business was worth $100 billion, and it was trading at a value of $45 billion. That is value investing 101; buy when it's undervalued, and sell when it's fairly valued. 

His next venture into the resource sector began in 2008, when he purchased shares in ConocoPhillips. This investment was made because Buffett claimed that the energy sector provided him the product stability that he desired. 

This investment ended up costing Berkshire Hathaway several billion dollars. The first reason this investment failed was he broke his own rule; and that is "if you can't understand it, don't do it." Although a great investor he maybe, he clearly didn't understand the resource sector. Look at this chart below. 



As you can see from the chart above, the price of oil is anything but stable. In the middle of 2008, the price of oil was near its all-time high. The resource sector is the most cyclical sector in the equities market. Warren Buffet's ConocoPhillips investment cost Berkshire Hathaway billions of dollars because he didn't follow the cyclicality that's involved when investing in the resource sector. This is also why his investment in Energy future holdings failed. He purchased their bonds when Natural Gas prices were near their high.  

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About the Author

John Manfreda, http://oilprice.com