Skip to main content
The Globe and Mail
Support Quality Journalism.
The Globe and Mail
First Access to Latest
Investment News
Collection of curated
e-books and guides
Inform your decisions via
Globe Investor Tools
Just$1.99
per week
for first 24 weeks

Enjoy unlimited digital access
Enjoy Unlimited Digital Access
Get full access to globeandmail.com
Just $1.99 per week for the first 24 weeks
Just $1.99 per week for the first 24 weeks
var select={root:".js-sub-pencil",control:".js-sub-pencil-control",open:"o-sub-pencil--open",closed:"o-sub-pencil--closed"},dom={},allowExpand=!0;function pencilInit(o){var e=arguments.length>1&&void 0!==arguments[1]&&arguments[1];select.root=o,dom.root=document.querySelector(select.root),dom.root&&(dom.control=document.querySelector(select.control),dom.control.addEventListener("click",onToggleClicked),setPanelState(e),window.addEventListener("scroll",onWindowScroll),dom.root.removeAttribute("hidden"))}function isPanelOpen(){return dom.root.classList.contains(select.open)}function setPanelState(o){dom.root.classList[o?"add":"remove"](select.open),dom.root.classList[o?"remove":"add"](select.closed),dom.control.setAttribute("aria-expanded",o)}function onToggleClicked(){var l=!isPanelOpen();setPanelState(l)}function onWindowScroll(){window.requestAnimationFrame(function() {var l=isPanelOpen(),n=0===(document.body.scrollTop||document.documentElement.scrollTop);n||l||!allowExpand?n&&l&&(allowExpand=!0,setPanelState(!1)):(allowExpand=!1,setPanelState(!0))});}pencilInit(".js-sub-pencil",!1); // via darwin-bg var slideIndex = 0; carousel(); function carousel() { var i; var x = document.getElementsByClassName("subs_valueprop"); for (i = 0; i < x.length; i++) { x[i].style.display = "none"; } slideIndex++; if (slideIndex> x.length) { slideIndex = 1; } x[slideIndex - 1].style.display = "block"; setTimeout(carousel, 2500); } //

An Exxon sign is displayed at a gas station in Carnegie, Pa.

Gene J. Puskar/The Associated Press

Jim Chanos is the most prominent and successful short seller in the world, but I bet even his face went white on discovering Warren Buffett was buying the Exxon Mobil shares he was selling.

In a presentation at the Reuters Global Investment Outlook Summit last week, Mr. Chanos disclosed a short position in U.S. oil giant Exxon Mobil Corp., describing the stock as a "value trap." Only days previously, Berkshire Hathaway regulatory filings disclosed that Mr. Buffett had built a $3.5-billion long position.

Adding to the intrigue, Mr. Chanos cited cash flow sustainability and return on equity (ROE) as the reasons for his skepticism – the exact two multiples that form the foundation of Mr. Buffett's investing approach.

Story continues below advertisement

Warren Buffett is arguably the best investor of all time, so usually investors can dismiss opinions that contradict him out of hand. But within financial circles, Mr. Chanos is almost as revered.

Mr. Chanos is the founder of $6-billion hedge fund management firm Kynikos Associates (kynikos is the Greek work for cynic). He rose to prominence with wildly successful short positions in Enron Corp., Hewlett-Packard, Tyco International Ltd. and more recently, Caterpillar Inc. and Chinese real estate development stocks.

In Mr. Chanos's view, Exxon's declining return on equity and cash flow make it a value trap – a cheap stock that will just get cheaper as profitability deteriorates. The accompanying chart shows he has a point. Exxon's return on equity – the most widely used measure of a company's ability to turn revenue into profits – hasn't come close to pre-crisis levels and has trended lower throughout 2013.

The other line on the chart, cash flow per share, is likely what Mr. Buffett is looking at. His investment style, stated simply, is to buy companies with cash flow streams that are near-bulletproof – rarely changing from year to year – at times when the stock's price-earnings ratio is at least 30 per cent below the long term average.

Exxon fits the bill in terms of cash flow. Despite the decline in ROE, quarterly cash flow has rarely been outside of a $2 to $4 range. This is a remarkable feat in light of crude price volatility.

The current trailing price-earnings level is almost exactly in line with the 10-year average of 12.0. But, there's been numerous times this year when the stock traded at P/E levels in the 10.5 times range, which would have offered a valuation discount to history.

At the risk of being branded a heretic, I suggest that Mr. Chanos has this right. Mr. Buffett's belief that Exxon's cash flow will remain consistent is predicated on oil being as profitable to find, pump to the surface and transport as it has been in the past. Much of Exxon's stable cash flow in the past 10 years has been accompanied by return on equity levels above 30 per cent. The current ROE, only marginally above 20 per cent, suggests profitability is already declining and that future cash flows are increasingly threatened.

Story continues below advertisement

It is also unlikely that Mr. Buffett acquired his position at the usual steep valuation discount.

The outlook for North American crude prices also supports Mr. Chanos's skeptical outlook. Sharply rising U.S. oil production and increased exports from Iran will pose a major hurdle for the West Texas Intermediate (WTI) spot price.

Betting against Warren Buffett has been among the worst investing strategies imaginable, so I'm not about to suggest investors join Mr. Chanos in shorting Exxon. But investors should think very hard before blindly following Mr. Buffett this time.

Your Globe

Build your personal news feed

  1. Follow topics and authors relevant to your reading interests.
  2. Check your Following feed daily, and never miss an article. Access your Following feed from your account menu at the top right corner of every page.

Follow the author of this article:

View more suggestions in Following Read more about following topics and authors
Report an error Editorial code of conduct
Tickers mentioned in this story
Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

  • Treat others as you wish to be treated
  • Criticize ideas, not people
  • Stay on topic
  • Avoid the use of toxic and offensive language
  • Flag bad behaviour

If you do not see your comment posted immediately, it is being reviewed by the moderation team and may appear shortly, generally within an hour.

We aim to have all comments reviewed in a timely manner.

Comments that violate our community guidelines will not be posted.

UPDATED: Read our community guidelines here

Discussion loading ...

To view this site properly, enable cookies in your browser. Read our privacy policy to learn more.
How to enable cookies