The energy sector has been crushed since crude started declining from its record high of $147.27 in July to around $57 today.

Suddenly, what was “hot” was “not.”

Investors raced for the exits and nearly all energy and energy-related stocks took a beating.

That includes shares of the “big boys”- Exxon (XOM), Chevron (CVX) and ConocoPhillips (COP).

Berkshire Beefs Up Energy Stake

On Friday, it was revealed that Berkshire Hathaway has been accumulating more shares of ConocoPhillips.

From the AP:

Friday’s filings reveal that Berkshire’s stake in ConocoPhillips grew from 17.5 million shares in March to 59.7 million shares in June and about 84 million in September.

This news shouldn’t come as any surprise to those who follow Berkshire Hathaway and Warren Buffett. A few months ago, Buffett was on CNBC and could not talk about the ConocoPhillips holding- which meant that he was either selling or buying.

It didn’t take a genius to figure out he was buying. At the time, the stock was trading around 5 times forward earnings. Even with the drop in crude, COP is still a cheap stock and is trading near its 52 week low.

Buffett knows energy demand isn’t going to go away tomorrow so he’s adding to his position right now- while it’s still cheap.

The Energy Sector Is At Multi-Year Lows

The S&P Energy Index is trading at about 6 times earnings- which is the lowest the sector has been since 1996. Remember how out of favor it was then?

Yet, the earnings are still there. Lowered crude prices will help with refining margins. The big integrated companies will no longer see record profits- but they’ll see healthy earnings (which is more than most sectors right now.)

The recent sell-off was irrational. But it presents investors with an opportunity.

Buffett is seizing the day. If you don’t already own energy stocks, now might be a good time to take another look at the sector.

Last Friday was nirvana for those following financial news.

On the one hand, you had Warren Buffett, the greatest living investor in the world (maybe the greatest investor ever), on CNBC for three hours on Friday morning. He espoused on a variety of topics such as how many cherry cokes he would drink during the show to the slowing of the economy.

But his most interesting comments were on inflation.

Buffett Warns about Inflation

Berkshire Hathaway, as you know, controls quite a few companies. I’m ashamed to admit I don’t know how many (dozens?). They own everything from Pampered Chef to Geico to Dairy Queen. Berkshire’s companies are in a wide range of industries.

While Warren doesn’t himself run all of those companies, as Berkshire’s CEO, he gets monthly reports from his managers telling him what is going on with each business.

He said the July reports were interesting. He gave a specific example of one of their carpet businesses which he said the carpet was basically made out of oil (bet you didn’t know that carpeting is a petroleum-based product. But that’s a subject for another post.)

He said that company was getting price increases nearly every day from its suppliers and that of course it was pushing through price increases on its own products as its margins were shrinking. But even with the increases- the company couldn’t keep up with rising raw material costs.

Asked by CNBC’s Becky Quick if these price increases will be seen throughout the economy eventually- he answered “yes” and thought that the CPI would be reflecting them soon. He basically didn’t believe that the CPI was measuring the inflation in the economy.

His comments on inflation are exactly those that I’ve been hearing from many others in the business community. As I’ve said before- the inflation genie is out of bottle.

Bernanke said inflation will “moderate”

Ben Bernanke, the Fed Chairman, gave a speech in Jackson Hole, also on Friday, discussing the state of the economy. From the Financial Times:

Speaking at the start of the Federal Reserve’s annual retreat in Jackson Hole, Wyoming, Mr Bernanke said the shift in currency and oil prices, as well as weak growth, “should lead inflation to moderate this year and next”.

Such a scenario would mean that commodity prices would likely have to fall even further than they have in the last month.

There’s no doubt that inflationary pressures ease as growth slows. But companies continue to push through the price increases and it’s unlikely that they will suddenly stop and roll them back.

Are any of the airlines saying they’re getting rid of their baggage fees now that crude has fallen below $120 a barrel?

I haven’t heard of any.

Instead- all I’m hearing about is more price increases on goods and services.

Hershey’s just announced it was raising prices 11% after already raising prices last January. Mars also announced it too would raise prices- but didn’t say by how much. Mars also raised prices last January- following Hershey’s lead.

This all comes on the heels of the chemical companies announcing 20% increases.

Who Do You Believe?

The stock markets all rallied on Bernanke’s comments- virtually ignoring the Sage of Omaha. Moderating inflation sounds wonderful, doesn’t it?

Bernanke v. Buffett.

Academic v. CEO.

A wise investor would be smart to listen to Mr. Buffett.

Who’s going to put the inflation genie back in the bottle? Looks like it won’t be Fed- at least not under this Chairman.

Berkshire Hathaway had its annual meeting this weekend so Warren Buffett has been all over the media and CNBC answering questions.

What does Warren know about the general economy? CNBC has been asking him questions about the rate cuts, whether or not the stimulus will work, if the Fed is done cutting rates, whether or not Bear Stearns should be bailed out etc.

What does Buffett know about these issues? He is NOT an economist. Yes, he runs a company that has a lot of different divisions, such as Sees Candy and Dairy Queen, that would give him insight into what the consumer is thinking.

But that doesn’t mean he “knows” what is going to happen. He’s just guessing- like the rest of us.

What does he know about the stimulus? He has no idea whether or not the average Joe or Jane will be spending it or putting it to their credit card debt. (My take: they spend it.)

Buffett has said in the past that he doesn’t believe in market timing. So why is he answering these questions then? How does Buffett know if the Fed is done cutting rates? He doesn’t.

What Buffett knows is valuing and investing in companies. The questions about whether Bear Stearns should have been bailed out are justified. Buffett himself was involved in bailing out Morgan Stanley less than 20 years ago. From the LA Times:

He said the Federal Reserve’s bailout of Bear Stearns Cos. probably prevented a crisis among investment banks because Bear Stearns held a large number of derivative contracts with other investment banks. If Bear Stearns went bankrupt, all those derivatives would have to be valued at zero or unloaded quickly.

But he and Munger agreed that not every business or investment bank should be rescued, because failure is an important part of capitalism.

“Capitalism without failure is like Christianity without h*ll,” Buffett said.

ha! ha!

Now THAT is what we like about Buffett. He gets straight to the point.

Let’s quit asking him general economic questions. Let’s ask him about what he knows best and that’s valuing companies.

The current financial crisis is a byproduct of a system that encouraged executives to “paint pretty pictures,” Buffett said.

Munger said lots of financial institutions acted with stupidity and overreached to improve earnings in recent years. “I think you have to start with the idea that a lot of the current troubles are richly deserved,” Munger said.

The complexity of the tactics that financial institutions often employ makes it difficult to determine what those companies are worth — even for Buffett.

“There are some financial institutions I can’t value,” Buffett said.

Listen to Buffett about the financial companies. Even HE can’t value them. Neither can you.

Do as he does.

Did you catch the interview with Warren Buffett on CNBC yesterday talking about the Mars/Wrigley merger? Buffett’s Berkshire Hathaway is providing $6.5 billion in financing for the deal.

Buffett loves brand name companies. He owns Sees Candies, Dairy Queen and Pampered Chef. He also owns shares in Coca-Cola- one of his longtime favorites.

Investing Rule No. 1: Buy Great Brands

What he has encouraged investors to do, over the years, is to buy stock in companies in which you know their product and it has withstood the test of time.

Yesterday, he talked about the “70-year taste test” for both the Mars and the Wrigley brands. If people bought gum and candy bars 10 years ago- the likelihood that they’ll be buying those items in another ten years is pretty high. From the interview:

Buffett: Yeah. Both companies have great brands. When I talk to classes of university students, for a dozen years or more I’ve used Wrigley as an example … I haven’t known about Mars except that they’re a provate company. But there is really nothing that can go wrong with something like the Wrigley or the Mars brands. It’s literally true that they have, ah, faced the test of time over decades and decades and people use more and more of their products every day.

That makes sense, right?

Investing Rule No. 2: Watch out for Inflation

Carl Quintanilla: Warren, we all know that a lot of the companies in this space are leveraged to the price of commodities, whether it’s cocoa, or what have you. Do you have a comment on what we’ve just been talking about the past week, whether it’s grains, or just global commodities in general. Does it feel toppy to you?

Buffett: Well, I’ve got a son that’s a farmer. He’s a very happy fellow. They used to tell the story out here in Nebraska about the farmer that won the lottery, and they sent a television crew out to see him. And the television interviewer said, ‘You know, you’ve just won twenty million dollars in the lottery, what are you going to do with it? And the farmer said, ‘Well, I think I’ll just keep farming until it’s all gone.’ (Laughter.)

Well, that was the situation in farming until the last year or so, but it’s a different world now. And I don’t know how much ethanol contributed to it, but, you know, you get twelve dollar soybeans and six dollar corn and that sort of thing, and it’s going to have an effect. I’m amazed we haven’t seen more inflationary effect so far with the CPI, when you consider what steel is doing, what oil is doing, what grains are doing, there is a lot of potential inflation down the road.

If all the underlying commodity prices are soaring- isn’t that inflationary? Of course it is. Be warned.

Investing Rule No. 3: We’re in a recession

Buffett: Yeah. I think we’re in a recession. I mean, a recession is defined in a certain way by the National Bureau of Economic Research, but I think it’s defined by the man in the street a little differently than whether there have been two quarters of reported (negative) GDP growth.

And incidentally, when GDP growth is below 1% a year it’s really falling on a per capita basis because our population increases about one percent. So even though the National Bureau uses an absolute figure, it’s up one-tenth they don’t count that as a recessionary quarter, but the GDP per capita has gone down in a quarter where the gain is half a percent or something of the sort. We are in a recession, unless you want to stick strictly to the technical definition, which I really don’t think has much meaning to the fellow who has lost his job or is facing a money-market fund that isn’t paying him out, or whatever it might be.

Berkshire Hathaway owns many consumer-friendly businesses such as furniture stores, jewelry stores and food. Berkshire has seen the consumer slowdown and he/she hasn’t started picking up.

Investing Rule No. 4: When you see an opportunity, take it

Farr: When you look at this deal, why now? The economy, if things are contracting and we’ve got rates where they are, why is this a good time for an acquisition? And do you have any integration concerns as Mars begins to take on this public company?

Buffett: Well, I think a good time to buy a really great business is when you can do it. Many, many years ago, as I remember, Herman Lay offered the Frito-Lay company to Coca-Cola. And he offered them the company first, as I understand it, and they decided for one reason or another they didn’t want to do it then. And of course Pepsico bought it and it’s the best thing they ever did. So if you get a chance to buy a wonderful business, then my advice is, grab it. As Yogi Berra would say, ‘When you come to a fork in the road, take it.”

You never know when an opportunity will present itself. Opportunities don’t wait for the “right” economy or the bull economy. They can happen in recessions, depressions, downturns, bears etc. Be prepared.

Investing Rule No. 5: Don’t Buy What you Don’t Know

Joe: And I know, you have a lot of utilities. And you had a big Petrochina investment in China. You sold out. Should we read into that, that maybe you’re not as active in that area as the situation seems to dictate at this point? Are we getting toppy? That’s the question I’m trying to ask you. I guess nobody knows. But is it crazy right now in commodities or is this the state of the world?

Buffett: Well, who knows on that? But I don’t play sectors, Joe. When I — the thing that makes my job fun is when I go to work in the morning, I don’t really know what’s going to happen. So, two months ago, I didn’t have the faintest idea I would be investing 6-1/2 billion of Berkshire’s money in this particular transaction. You know, and then the phone rings. I love it when the phone rings. Usually it’s the wrong number but every now and then something happens.

Becky: Although Warren, you have played some sectors in the past, with the transports playing on the rails, and other areas. You have not made broad commodities plays. Is there a reason for that?

Buffett: Well, it’s probably because I don’t know what commodities are going to do. The thing about commodities, if I knew what commodities were going to do, I wouldn’t have to play them through stocks. I could just go on the commodity market and do it. So, I, I don’t know what oil or wheat or soybeans or cocoa or anything like that’s going to be selling for next week or next month or next year. I do know people are going to be chewing Wrigley gum and eating Mars bars.

Buffett doesn’t follow the grain markets everyday, so why would he invest in them? Who knows what grains will do?

But, again, he KNOWS what Wrigley gum is going to do- because it has essentially done it for the last 70 years. The history is there. The market is there. It’s not speculative.

Lessons from Warren:

Buy what you know and understand. Buy great brands. Be patient and look for opportunities. They may present themselves when you least expect it.

Again, it sounds simple, doesn’t it?

He makes it look so easy.