What Warren Buffett is Signaling about the Economy

Two weeks ago, Warren Buffett made big news when he announced his company, Berkshire Hathaway, was purchasing Heinz (HNZ), the famous ketchup and food producer. The deal was announced during a busy week for mergers: That same week the American Airlines/U.S. Air merger was announced, as well as Dell being acquired by a private group of investors.

“It’s our kind of company. I’ve sampled it many times.” — Warren Buffett speaking about the Heinz deal in a CNBC interview

So it was a busy week. As a result there wasn’t the intense focus in the media on the Berkshire/Heinz deal as there might have otherwise been.

My colleague Mike Larson touched on the Buffett purchase last Friday. And after taking some time to review the acquisition, I can’t help but think that Warren Buffett may be giving us some insight into what he thinks will happen to the economy. Now, before I get to those thoughts, let me first say that companies do mergers for a whole host of reasons, and some have absolutely nothing to do with the greater economy — so looking at mergers as a commentary on the economy can be a fool’s errand, with exceptions.

And …

This is One of Those Exceptions

Heinz is a food producer, again best known for its ketchup, but it makes other food products too. You can’t find much more of a consumer staple than food (and ketchup). But, Heinz isn’t exactly an engine of growth — meaning they aren’t going to trade at a high P/E or see huge revenue or earnings growth, given their products are already so entrenched in the market.

But keep in mind there are two ways you can make a company more profitable:

The first is by increasing revenues, which we just discussed isn’t going to happen on a large scale.

The second is by increasing margins on your existing revenues. And I believe therein lies the subtle commentary on the outlook for the economy contained in the purchase.

We all know that central banks around the world are flooding economies with cheap money, all with the hopes that this cheap money helps economies begin to grow again. The tactic has had limited success due to numerous factors.

But most analysts, including me, think all this easy money will eventually lead to inflation, specifically commodity price inflation. So what happens when the price of say, tomatoes, or other foods goes up — well so do the prices of the end goods (ketchup). And seeing as food is a consumer staple, what you get is steady revenues and increased margins — which is a recipe for higher profits.

How You Can Profit from

Higher Food Prices

I believe Warren Buffett’s purchase of Heinz reflects his belief that we are going to see food price inflation in the coming years. And he wanted to get exposure to that trend by buying a company that stands to profit as food prices surge.

For us who aren’t able to spend 28 billion on a food company, we can follow Buffett’s lead by allocating to the consumer staples sector generally, and select consumer staples stocks — stocks whose products won’t see demand decline because of higher prices.

One idea to consider is Consumer Staples Select Sector SPDR (XLP). This ETF hold companies like Procter & Gamble, Coca-Cola, and Colgate-Palmolive. And it’s a recent addition to Dr. Weiss’ Million-Dollar Contrarian Portfolio.

As I said, often times it’s a fool’s errand to look at mergers as a commentary on the future of the economy. But when Warren Buffett speaks, it pays to listen. And in this regard I think he’s signaling he sees consumer staples, and specifically the foods sector, as some of the better areas to invest in the coming years.

Best,

Tom