The Four Things Warren Buffett Should Do Right Now

Andy Obermueller's picture

Friday, July 24, 2009 - 4:56pm

by Andy Obermueller

Warren Buffett has sold 16% of his 48 million shares in Moody's Investors Service (NYSE: MCO), which he has held since 2000. It's exactly the right move. Earlier in the week I wrote that this should happen after reading the lawsuit filed by the California Public Employees Retirement System, which accuses the credit rating agency of incompetence and other improprieties.

Moody's and the other two major credit rating agencies, Fitch and Standard & Poor's, are also coming under regulators' microscopes. This risk evidently outweighed the upside, and Buffett unloaded shares.

Certainly Mr. Buffett -- whom I have long studied and admired -- didn't sell his shares because I said so. And while it's clearly presumptuous for me to offer the Oracle of Omaha advice, there are four suggestions I would like to pass along for how Buffett can increase shareholder value at Berkshire Hathaway (NYSE: BRK-B).

Here are my four suggestions:

  • Buy CIT's rail-car leasing division.

CIT Group (NYSE: CIT) is a commercial finance company that has experienced a cash crunch. Its borrowers -- about one million businesses -- are having a hard time paying back their loans. CIT has a deal with bondholders in place that staved off bankruptcy, but it may prove to be a temporary reprialink_32889478e. The company, which bet on a government bailout that didn't materialize, now needs to sell some assets to raise cash.

Buffett should revisit buying CIT's rail-car leasing division. It's the third-largest rail-car business in the country. It has the requisite sustainable competitive advantage Buffett demands because of its size, customer base and existing fleet. The unit produces a steady and reliable source of income and won't require significant additional investment.

This deal would make some sense: Buffett loves railroads and is already a major holder of Burlington Northern Santa Fe (NYSE: BNI), Norfolk Southern (NYSE: NSC) and Union Pacific (NYSE: UNP).

Not only would the division be a nice fit for Berkshire, but it would also go a long way toward saving CIT. That would help burnish Buffett's image, which was somewhat hurt by his performance last year.

  • Sell The Washington Post and get out of Gannett.

Buffett's association (he's on the board) with The Washington Post Company (NYSE: WPO)  came from his long friendship with its former publisher, the inimitably wonderful Kay Graham. The Post has suffered, along with the rest of the newspaper industry. Buffett is also exposed through his ownership of shares in the publisher Gannett as well as through Berkshire Hathaway's direct ownership of the Buffalo News.

There is much at play with Buffett's affection for newspapers. One of his first jobs was delivering The Washington Post. That combined with his deep personal friendship with Mrs. Graham obviously engenders a certain nostalgia. Adding to that is the fact that a Nebraska paper Buffett owned won a Pulitzer Prize for a story he tipped them off to (the Pulitzer is in Buffett's office).

All of this clouds Buffett's otherwise sharp business judgment. Kay Graham, alas, is gone and the newspaper business is dying. Buffett's Washington Post stock lost more than $300 million in value last year. His Gannett (NYSE: GCI) shares were down -70%. While the Buffalo News likely has more than paid for itself, the stakes in the Post and in Gannett have no chance to make up this lost ground.

  • Enter the Medical-Records Business.

President Obama -- whom Buffett has generously supported -- has allocated $19 billion to change the way the nation stores its medical records. The digital transition will save money and help the system to operate more efficiently, two things Buffett doubtlessly approves of.

There are several key players in this industry. One that Buffett should consider is Quadramed (Nasdaq: QDHC). It's a company that would normally be under his radar because it's too small, with a market cap of only about $55 million. But Buffett didn't buy See's Candy because it was competing with Hershey (NYSE: HSY). He bought it after his partner Charlie Munger talked him into it because of the cash it could generate over time. That is, likewise, an excellent reason to look into this company.

I know Buffett likes to buy industry leaders. This company is the only one out there that has ever designed a wide-scale digital medical-records system. It's still in use by the Veterans Administration.

  • Invest in Desalinization.

Buffett bought into Moody's (NYSE: MCO) -- the old Dun & Bradstreet at the time -- because it has what he calls a "moat," that is, a protective barrier around the business' ability to generate a profit. For the ratings agencies, that moat is limited competition in a regulated field. It works: Moody's had the highest profit margin in the S&P for five years running.

If a wide moat and a leading industry position are what makes Buffett happy, then he should consider looking into desalinization. His recent purchase of Iscar, an Israeli cutting-tool company, has taken him to the Middle East, which shares access to a mere 1% of the world's available drinking water. Protecting a supply of drinking water is a major security concern since every major freshwater source in that troubled region crosses at least one international boundary.

The inevitable solution is desalinization, the process by which the deadly salts are removed from seawater to make it drinkable.

Desalination plants are at best expensive to build and operate, but they're totally cost-prohibitive without a key component that allows them to recycle energy. One manufacturer owns 70% of the market for this equipment. That's a good business, and here's what makes it great: It's growing. The desalinization industry is expected to double in the next 10 years as the Middle East, Africa and even California require more water than they have.

This manufacturer is an outstanding buy, especially in advance of the U. N. Climate Change Conference in Copenhagen this December, which is going to spur interest in -- and buying of -- critical environmental firms like this one. I'm talking about Energy Recovery Inc (Nasdaq: ERII) and I just added shares to my Government-Driven Investing portfolio on July 6th. Go here to see why I think ERII can help solve the world's water crisis and make early investors a killing at the same time.

My four suggestions above will protect Berkshire's assets from losses -- or further losses -- and put them in a position where they can grow in value and add to the sacred shareholder-equity line on Berkshire's balance sheet.

Andy Obermueller does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of cit in one or more of its “real money” portfolios.