Did Warren Buffett Buy the Wrong Energy Stock?

energy-stockIn the second and third quarter of 2013, Warren Buffett accumulated nearly 40.1 million shares of energy behemoth ExxonMobil (NYSE: XOM). Buffett’s cost basis is estimated at $90.22 a share.

Nine months later, ExxonMobil’s share are up roughly 8.1%. Toss in three-fourths of the $2.52 annual dividend, and Buffett has likely realized a 10% return on his investment.

I understand Buffett’s affinity for ExxonMobil. It’s a great company, and a big one. ExxonMobil is the second largest publicly traded company in the world, second only to Apple Inc. (NASDAQ: AAPL). Size isn’t necessarily correlated with greatness, but ExxonMobil continually generates high return on equity compared to the competition.  It also continually grows the top line 4% to 5% annually, EPS 6% to 7% annually, and the dividend 8% to 9% annually. This is an admirable feat for a company with over $400 billion in annual revenue.

The problem with ExxonMobil is its greatness: Everyone knows its great, and that’s priced into its shares.  My question is how much greater can this great company become? I doubt much greater, which is why I think ExxonMobil’s upside is muted.

Now, compare ExxonMobil to a more pedestrian competitor, the French energy giant Total SA (NYSE: TOT), which I recommended to High Yield Wealth readers in May 2012.

When I first recommended this energy stock it was a mess: One of its North Sea drilling platforms had spewed hundreds of thousands of cubic meters of natural gas into the air and ocean. Cost of clean up and litigation were a concern: Would the cost tally to a billion dollars, or multiple billions?

At the same, the European Union was under duress with the impending economic collapse of Greece and rumors of possible debt defaults in Italy and Spain.  Adding insult to injury, the French had just elected a raging socialist as their prime minister.

Total’s shares, which yielded close to 8% at the time of my initial recommendation, were hardly priced for perfection.  Indeed, they were more priced for catastrophe.  The upside is that that something priced for catastrophe frequently offers more upside potential than something priced for perfection.

My rationale is grounded in expectations: Circumstances are rarely as good or as dire as the moment leads you to believe. Total’s problems were hardly catastrophic, and that reality soon revealed itself: The North Sea mishap was rectified and the environment was scrubbed and clean at an inconvenient, but serviceable, cost; Greece, Italy, and Spain are still with us to this day; and France’s socialist prime minister has proven to be refreshingly feckless at destroying the local economy.

To be sure, Total is less great than ExxonMobil, but it’s still a solid energy giant, generating over $200 billion in annual revenue.  As more investors realized the obvious – this energy stock was here to stay – Total’s share price recovered. When dividends and price appreciation are factor in, Total has returned over 57% since my initial recommendation.  An ExxonMobil recommendation would have returned less than half of that, despite being the “greater” company.

Even a more contemporary Total purchase would have outpaced ExxonMobil.  If we go back to June 2013, representative of Warren Buffett’s ExxonMobil cost basis, Total has provided the superior return: Total shares are up nearly 30%, more than triple ExxonMobil shares.

Total SA and ExxonMobil Share-Price Appreciation

energy-stock-warren-buffett

Over 12 million ExxonMobil shares change hands daily, compared to one million Total shares.  If you were to invest $3.6 billion in an energy company, like Warren Buffett did, ExxonMobil would have been the more efficient, more expedient option.

But if efficiency and expedients weren’t factors, Total would have been the way to go.

I still view this energy stock as the superior investment: Its shares yield 4.9% compared to ExxonMobil’s 2.6%. Just as important, Total still has more room to improve than ExxonMobil. Total’s return on equity and operating margins are roughly half those of ExxonMobil.  This perceived weakness is actually Total’s strength: Improving from a lower basis offers more opportunity for large percentage gains than improving from a higher basis.

Keep in mind that a superior company is not synonymous with a superior investment. ExxonMobil is the former, but Total is the latter.

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Published by Wyatt Investment Research at