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Rupert Hargreaves
Rupert Hargreaves
Articles (418)  | Author's Website |

Warren Buffett Makes Good on a Little Known Oil & Gas Stock

Warren Buffett's old writings about the security he likes best

February 06, 2018

In the 1950s, a young relatively unknown, investor called Warren Buffett (Trades, Portfolio) wrote several articles for the Commercial and Financial Chronicle, as part of its 'The Security I Like Best' column.

The most famous of these pieces profiled what Buffett believed was the best stock at the time, GEICO. This particular article was written and published at the beginning of December 1951. However, over the next ten years, Buffett wrote three other articles for the paper profiling three more securities he liked, all of which conformed to the value investor's criteria of being cheap and misunderstood by the rest of the market.

What's fascinating about these letters is they display and give great insight into Warren Buffett (Trades, Portfolio)'s analytical mind early on in his career. All of the articles walk through the investment process for these companies, picking out their most attractive qualities and drawbacks, as well as highlighting value. The one thing that unites all of them is that they are cheap, tiny and uncovered by the rest of the market. What's more, they're very misunderstood due to complex factors that are hiding the value. Because Warren Buffett (Trades, Portfolio) was able to spend time on each company researching why it was cheap, his unrivaled focus gave him an edge over other market participants, allowing him to make big bucks while others struggled.

One of these companies that he profiled in 1957 was Oil and Gas Property Management.

Buffett on oil & gas

Like all of Warren Buffett (Trades, Portfolio)'s early ideas, the main attraction with this stock was its valuation. At the time of the article, the market capitalization of the business was just $5 million, which dramatically undervalued the business's properties.

This was a levered asset play more than anything else. O&G had been funded with $10 million in income debentures and 300,000 shares of stock. The company then went on to acquire many oil properties, which it financed with loans efficiently guaranteed by these properties' income streams. As Buffett describes:

"Purchases have been made subject to substantial oil payments with a large portion of income in early years used to extinguish these payments. This method might be compared to real estate purchased subject to large mortgages with rental income, exclusive of that portion needed for operating expenses, utilized for mortgage reduction."

At the end of 1955, the company had $49 million of these oil payments remaining and $17 million of loans and debentures ahead of 380,000 shares of common stock. $33 million of the total oil payment was related to just one property. The balance of $16 million was split between the remaining properties and reduced by $4 million in 1955 alone leading Buffett to conclude that the " average payout on these is probably less than three years away." Against the $65 million of obligations, Buffett calculated that the total value of the business's oil and gas reserves was $150 million.

And the potential excess return available if oil and gas prices were to rise even by a small amount, was enormous:

"An increase in the price of oil of 15 cents per barrel or one cent per MCF in the case of gas is equal to the entire market value of the common. If oil over the next few years were to increase in price 50 cents per barrel, the gain in market value would be equal to almost 400% of the current total market price of the common."

It is no surprise that after reviewing this leveraged, well-capitalized oil business, Buffett concluded, "a small investment in O&G should do the job that a many times larger investment in a non-leveraged oil holding would do while exposing the holder to a much smaller maximum loss." A true Benjamin Graham stock because it had the potential to make a return multiples of the current price while having minimal downside risk.

(Disclosure: The author owns no stock mentioned.)

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. Prior to his investing and writing career, Rupert was as a proprietary currency trader. Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

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