Buffett's Favorite Income Investment
By Tom Dyson
Wednesday, March 25, 2009
In 1977, a newspaper from Buffalo sued Warren Buffett.
At the time, Buffalo had two newspapers. Warren Buffett had just bought the Buffalo Evening News. The Buffalo Courier-Express was worried Buffett was trying to run it out of business to get a monopoly on Buffalo's advertising revenue.
The judge agreed and ordered an injunction against Buffett's newspaper.
"There are only two newspapers now," said the judge. "If [Buffett's] plan works as I find it is intended to work, there will be but one left."
Before the Internet and local television broadcasting, a single newspaper in a medium-sized town like Buffalo was a great business. There was no other way for businesses to contact their customers, so the newspaper was like a "toll bridge" connecting businesses and potential customers. It could raise advertising rates – tolls – through the roof, and businesses wouldn't be able to do a thing about it.
But sharing the market with another newspaper is a lousy business. Buffett had no pricing power and only half the customers. So Buffett bought the Buffalo Evening News and tried to bankrupt his only competitor. The judge's injunction lasted for two years until the appeals court overturned it. In 1982, the Buffalo Courier-Express went out of business, and Buffett's newspaper started making huge monopoly profits.
Toll- bridge businesses are Buffett's favorite businesses... especially when they operate in uncompetitive markets. He invested in ABC television in 1979, when there were only three networks. American Express is another famous Buffett investment. It's a toll bridge collecting interest from consumers and fees from merchants for using Amex's payments system.
Notice all these businesses have the same characteristics. They all provide basic services. And after the initial costs of building the toll bridge, these businesses don't require much money to operate. The fees they collect are all profits. And they're hard to compete against. The upfront capital costs are huge, half the market is the best a competitor could hope for, and they won't have any pricing power unless they can afford to bankrupt the competition like Buffett did in Buffalo.
In The 12% Letter, we've invested heavily in low-competition toll-bridge businesses. They make excellent income investments. Because they don't have any major operating costs, management can pay out almost all the fee income to shareholders as dividends. Toll bridges are excellent inflation hedges, too. The upfront costs can be financed and paid back in devalued dollars over time like a mortgage, but the revenues rise with inflation.
My favorite kind of toll bridge is a pipeline company. These businesses move natural gas around the country in steel tubes buried six feet underground... an essential service that costs next to nothing to maintain. There's never any competition. And there's no commodity risk. No matter what the price of natural gas, the pipeline operator simply collects tolls. Plus, you've got the government on your side, giving large tax breaks to encourage investors.
The bear market has destroyed pipeline stocks. The Alerian MLP index is an index of the 50 largest pipeline companies. The index yields 10.5% right now, but it's easy to find individual pipeline companies with yields as high as 15%. Click here for a list of the pipeline companies in the index.
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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YOU HAVE NO CHOICE BUT TO BE BULLISH ON COPPER
Slowly but surely, copper is driving nails into its bear-market coffin...
Copper is one of our favorite "real world" indicators... The metal is used to build nearly everything from plumbing, power lines, and electronics to cars and refrigerators. This "in everything" attribute makes the price of copper an instant read on what's going on with the global economy.
Copper suffered a 66% decline in 2008... an extraordinary fall for such an important commodity. But as we've been covering, copper is actually rising in the face of terrible economic reports and headlines. It's a bullish sign if an asset rises when it "shouldn't."
As you can see, copper is building on the $1.60 "breakout" level we covered last week. Prices settled around a four-month high of $1.80 per pound yesterday. While watching this rally, please remember one of our DailyWealth mantras: Prices always lead the news. If copper can hold these levels, expect to see headlines reading "global economy showing signs of life" or "economic numbers better than expected" by this fall. We're rooting for you, copper...
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Copper stockpiling by a secretive Chinese state organisation has helped trigger an impressive rally of almost 35 per cent in the price of the metal this year.
Copper's fortunes are closely tied to the industrial cycle so the price jump, bigger than that of gold, has grabbed attention outside the commodities market, with some questioning whether it could signal a turning point for economic growth.
Industry reports point to buying by the Beijing's State Reserves Bureau, which manages the country's strategic stockpiles.
SRB's decisions are shrouded in secrecy, making it virtually impossible to assess accurately how much the Chinese government has bought. Traders estimate that the SRB is in the process of securing 300,000 tonnes and speculate that it could buy up to 1.2m tonnes this year. Global copper production last year stood at 18m tonnes.
– Financial Times
World airlines are set to lose $4.7 billion this year as a result of the global recession that has shrunk passenger and cargo demand, industry body IATA said.
The International Air Transport Association had estimated in December the industry would lose $2.5 billion in 2009.
"The state of the airline industry today is grim. Demand has deteriorated much more rapidly with the economic slowdown than could have been anticipated even a few months ago," Director-General Giovanni Bisignani said on Tuesday.
"The relief of lower fuel prices is overshadowed by falling demand and plummeting revenues. The industry is in intensive care."
– Reuters
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