By: Chris Rowe — April 30, 2019

Warren Buffett: OXY's Preferred

Legendary investor Warren Buffett is often blindly followed by investors looking to ride his coat tails.


After all, he has one of the best long-term track records on stock market investing.

But investors make one common mistake...

They don't understand that he gets certain guarantees and sweetheart deals that often insulate him from a major loss.

His latest investment, through Berkshire Hathaway, is $10 billion into Occidental Petroleum (Symbol: OXY) preferred stock.

Along with that investment, he gets warrants giving him the right to buy another $5 billion worth of common stock at $62.50.

(Click any image to enlarge)


Immediately, investors tend to think they should jump into the stock because: "If it's good enough for Buffett then it's got to be a great purchase."

After all, Buffett just acquired the right to buy the stock a few points higher than its current price of $58.98.

In fact, his investment is directly based on the notion that Occidental Petroleum and Anadarko Petroleum (an oil and gas driller that Occidental is currently trying to acquire) is a match made in heaven.

The deal is not yet done.  Occidental is in a bidding war with Chevron, which is five times larger...and better capitalized.

But hey, if Warren Buffett is betting $10 - $15 billion on it, then they've got to be a good fit.  Right?

Some investors might decide to "back in" to Occidental by purchasing Anadarko stock, since they're the one being acquired, and could eventually become Occidental.

And since they're the one being bought, their stock should go up...


Too late.

Sure, the stock could continue higher as the bidding war continues and the bid prices increase.  It all seems quite exciting.  But the fact is, this situation is loaded with bearish land mines.

First, Buffett's investment in the preferred shares is a high yield play.

Berkshire would get an 8% dividend, which is about the average annual return for the stock market.  Not bad.

Also, preferred stocks are very different from common stocks.

If a company goes out of business, preferred holders are paid after bond holders.  If there's anything left, common stock holders get the crumbs.  Preferred stock holders also have priority over common stock holders when dividends are paid.

Preferred stocks don't fluctuate very much either.  So don't think you're taking the same risk or getting the same reward that Buffett is getting.

What about his right to buy the common stock at a higher price than today's price?  This is virtually the same as a call option... only he isn't paying for it.

It's a "Thank You" for his cash infusion via the preferred stock.  It's a high end game of "Heads I win, tails you lose".  If the common stock declines, Buffett is sitting pretty with his 8% dividend... and his principle value won't decline by much.

In fact, if interest rates decline, his preferred stock will likely rise.

Furthermore, Buffett's investment in the preferred stock is contingent on Occidental Petroleum completing its proposed takeover of Anadarko Petroleum.  And it's worth noting that Chevron has made a $33 billion buyout offer for Anadarko.

This may be a lot to digest so let's pause for review:

  • Anadarko has a takeover bid from Chevron, so its stock jumped.  If you look at the price chart, you can see it actually jumped up to a historical point of resistance, typically a bad place to buy a stock.

    The bullish assumption is that it won't be "Anadarko" for much longer, so the resistance level may not be very relevant.  But the stock isn't a strong one, having declined from about $76 to $40 in the second half of 2018 and didn't rebound with the stock market early this year.  (It wouldn't look attractive at all, had this story not developed.  What if the deal falls through?)

  • Occidental Petroleum is trying to snatch Anadarko away from the very powerful Chevron, now with the backing of Warren Buffett.  What if they fail?
  • If Occidental succeeds, Buffett simply gets an 8% dividend, not having to keep up with inflation, not having to keep up with the stock market's average return.  If the stock goes up, he gets to own it from a pre-set price of $62.50.

Occidental Petroleum's stock chart looked a lot like Anadarko's stock chart prior to the takeover bid from Chevron.  Woof!

Who's Going to Push the Price Higher?

While Occidental has the backing of Warren Buffett, but if you were to buy the stock, you certainly would not.  He's going to be a buyer if and only if the stock ultimately rises far above the $62.50 strike price.  Plus, those shares will be newly registered shares.  There would be no new demand.

Which reminds me... there's one other major reason I'd stay the heck away from this...

The other Warren Buffett types don't have your back either.

You want to be invested in industry groups that the biggest, smartest, most informed investors are buying.  But they are selling the Energy sector.

When you divide the stock market into the 11 major S&P sectors... and then do relative strength price comparisons of the funds that track these sectors (a highly sophisticated algorithm that you'll have to trust me on for now), Energy is ranked dead last.

In order of strength, the 11 major sectors' relative strength rankings are:

  1. Technology
  2. Industrials
  3. Utilities
  4. Consumer Services
  5. Financials
  6. Consumer Cyclical
  7. Healthcare
  8. Consumer Non-Cyclical
  9. Real Estate
  10. Basic Materials
  11. Energy

Historically, investing in (and rotating into) the groups showing the most strength is what nets you above average returns.  Doing the opposite results in the opposite -- below average returns.  You want to be invested in the groups that institutions are buying aggressively -- not selling.

When we use the same sophisticated algorithms to find and rank the strength of the eight fixed income groups, what do you suppose is in the upper rankings?

Let's see...

  1. US High yield
  2. US Corporate
  3. US Preferreds & Convertibles
  4. Municipal Bonds
  5. Long Duration US Treasuries
  6. International Sovereign bonds
  7. Inflation Protected bonds
  8. Short Duration US treasuries

First, note that high yielding securities is at the top.  Preferred stocks are #3.  These are areas where Buffett's true investments are being made.

Next, consider what these rankings say about the future of the financial markets.  These rankings are almost perfectly showing us that higher risk is in demand, and that the safest and most conservative picks are showing the least demand (by large investors).

So... at the end of the day you would be correct in your assumption that investing alongside of the well-informed and biggest investors is a smart way to invest.

But you want to be sure that you're not blindly following what just one large investor seems to be interested in.

Invest Safely,

Chris Rowe

Founder, True Market Insiders




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