Warren Buffett, one of the world's most successful investors, has revealed his latest big buy.
Buffett's investment vehicle, Berkshire Hathaway [NYSE: BRK] has bought shares in oil giant Exxon Mobil [NYSE: XOM] worth $3.45bn. Berkshire now owns 0.9% of Exxon.
Buffett's move has triggered a fair bit of excitement about Exxon. The bulls have highlighted the fact that the company trades on a price/earnings multiple of just 11.8 times next year's earnings. It's also paying a 2.7% dividend, well ahead of the average for the S&P 500 index.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
It looks cheap, and Buffett is buying. Those are two good reasons to get excited about any stock.
But I don't think you should follow Buffett's lead. Here's why
Some of Exxon's biggest businesses are struggling
Refining is the worst of the three. Profit margins are thin and look set to stay that way. There is simply too much refining capacity around the world. Things are so bad in this sector that Exxon's refining profits have slumped 81% over the last year.
On the exploration side, oil exploration is also a tough business. Most of the low-hanging fruit was found long ago. If you want to find new oil reserves these days, you have two options.
You can explore in remote locations such as the Arctic or Kazakhstan. Or you can find ways of obtaining oil from fields where extraction was previously considered too difficult.
In fairness to Exxon, it's following both of these approaches. It's exploring in the Arctic as part of a joint venture with Russia's Rosneft, while it's extracting oil from oil sands (an unconventional source of oil) in the Kearl sands project in Canada.
The trouble is, these projects are expensive. Even if a project does eventually strike oil, it can be a long time before the exploration costs are paid off. For example, with its Kashagan project in Kazakhstan, Exxon doesn't expect a decent return until 2040, even although production has already commenced.
Remember also that some oil-producing countries have been keen to develop their own national oil companies. That's made it harder for the likes of Exxon to access fresh oil fields.
Production is the jewel in Exxon's crown but it's still a tough business
But that production can only be sustained if the exploration continues to be successful, and that's a huge challenge. Indeed, production has fallen over the last two years. That decline has only been arrested by production starting at Kearl sands.
So you can't assume for a moment that Exxon is a one-way bet that will carry on producing oil at current levels for generations to come.
And this is all before you throw in the wild card of climate change. It's tough to make any firm predictions here. But there has to be at least a chance that governments will eventually decide to aggressively clamp down on carbon dioxide emissions. One way or another, that won't be good news for any oil company.
I suspect that you might by now be wondering: "But what about shale oil? Hasn't that transformed the energy industry?"
And you're right. The boom in shale oil is a major change and has dramatically increased oil production in the US. Trouble is, Exxon doesn't have a big presence in shale oil, so shareholders can't rely on that, even if Exxon has a stronger position in shale gas.
Exxon might make sense for Buffett but you and I have better options
And with Exxon, he's got a large company, trading on a low rating, which also delivers an excellent 25% return on capital.
But as I'm much poorer than Buffett, I can choose from a much larger universe of potential investments. Given all the things to worry about with Exxon especially its growing costs of production I'd rather put my money in some smaller companies where I think the risks are lower. Over the long-term, I think they'll probably do better.
I mentioned some of the small companies I'm investigating in a recent Money Morning. And if you're interested in playing the shale revolution, my colleague David Stevenson over at the Fleet Street Letter has put together a report on the prospects for fracking in Britain you can read it here.
The Fleet Street Letter is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.
Our recommended articles for today
This invention transformed sports betting
Fracking debate: the readers weigh in
-
What is the 25x retirement rule and does it work?The 25x retirement rule has been around for decades but many experts question if it is a suitable strategy
-
When is the self-assessment tax return deadline?If you are self-employed, rent out a property or earn income from savings or investments, you may need to complete a self-assessment tax return. We run through the deadlines you need to know about
-
Investing in the energy sector – is the reward worth the risks?The energy sector used to offer predictable returns, but now you need to tread carefully. Is the risk worth it?
-
Best-performing stocks in the S&P 500We take a look at the best-performing stocks in the US equity market. Are there opportunities outside of Big Tech?
-
How to beat Warren Buffett – and the fund and trusts that have managed itWarren Buffett has achieved stellar returns for investors over a long and illustrious career. Can you rival his investment performance?
-
What is Vix – the fear index?What is Vix? We explain how the fear index could guide your investment decisions.
-
The case for dividend growth stocksMany investors focus on yield alone when looking for income, that’s a mistake says Rupert Hargreaves. It’s the potential for dividend growth that really matters.
-
Fractional shares: what are they and why HMRC is worried?Investors who have flocked to investment apps offering fractional shares in an Isa could lose the tax-free status of their portfolios.
-
Gilts look attractive, but trusts have more income growth potentialYields on gilts have reached levels not seen for 16 years, but with real yields still negative, investors should look to trusts instead.
-
8 ways to profit from Japan’s recoveryCorporate reform, normalising monetary policy and cheap valuations make Japanese equities a top long-term bet, says Alex Rankine.
