What Warren Buffett Is Buying -- and Why He's Buying It

When the World's Greatest Investor doles out free stock picks, long-term investors would be wise to pay attention. Billionaire Warren Buffett's Berkshire Hathaway (BRK.B) revealed what it's been buying and selling over the past few months in a recent routine regulatory filing, and suddenly the investing world was full of fearful chatter over the fact that Buffett pared his stakes in some of America's bluest of blue-chip companies.

But take a step back and you'll see that Buffett is still plenty bullish on the U.S.A. Besides, what Buffett is selling isn't nearly as important as what he's buying -- and why he's buying it. Berkshire upped its holdings in some very intriguing stocks, and that's where investors should look to profit from the the Oracle of Omaha's wisdom.

True, over the first three months of the year Berkshire cut its holdings in some of the biggest names around, including Dow components Kraft (KFT), Johnson & Johnson (JNJ), Procter & Gamble (PG) and Travelers (TRV). But that was hardly a vote of no-confidence in America.

Berkshire sold nearly a quarter of its stake in Kraft because Buffett thinks the food company overpaid when it bought Cadbury, calling it a "dumb deal" at Berkshire's annual meeting a few weeks back. (Berkshire still owns about $3 billion in Kraft shares, by the way.) As for the other blue-chip stock sales? They were done partly to pay for Berkshire's $27 billion acquisition of railroad Burlington Northern Santa Fe.

Make no mistake: There's no more bullish bet on the future of America than its railroads. They're the circulatory system of the economy.

Slow and Steady Wins for Warren

So, having put aside any fear over what Buffett is selling, let's get greedy and see what he's buying. Recall that Buffett invests for the very long term. He might have an estimated worth of $47 billion, making him the world's third-richest man, but it also took more than half-a-century of investing to get there. (And Buffett knows that starting young and learning patience is key to investing: Witness his new kids cartoon and website, Secret Millionaire's Club, that aims to impart such wisdom.)

How Buffett got to be where he is now can be seen in some of the stocks Berkshire raised its stakes in: Republic Services (RSG), a waste-management company; Iron Mountain (IRM), a data and document management company; and Becton, Dickinson (BDX), which makes medical products.

At first glance these three companies don't seem to have much in common. Upon closer inspection they all meet two of Buffett's most basic investing rules: Buy What You Know, and Book Value Is King.

As for the first rule, Buffett famously buys only businesses that he understands, and these three companies easily comply. What's so complicated about a garbage hauler, a document shredder and a company that makes stuff to cut people open?

Furthermore, they all have irresistible demographic forces fueling long-term revenue growth. Population expansion ensures that Americans will be generating more garbage and documents and data. Meanwhile, that great cohort of 83 million baby boomers is starting to get old.

Buffett's Bottom Line

But most important is that each of these three companies has relentlessly increased its book value per share over the last 10 years. Book value is a boring accounting term that describes the total value of a company's assets that shareholders would theoretically receive if the company were liquidated. Book value per share is just book value divided by the number of shares outstanding.

The thing about book value per share is that it's Buffett's bottom line. That's why he begins every annual letter to shareholders with a review of how Berkshire's book value per share is doing. It's how Buffett measures performance. Once you realize that, Berkshire's bets on Republic Services, Iron Mountain and Becton make complete sense.

Check out this chart we made using data from Capital IQ showing the companies' respective book values per share over the last 10 years. With nary a hiccup, these companies are creating and retaining accelerating value for shareholders through bull and bear markets alike.

Now, to get a sense of what rising book value can mean for investors, take a look at the stock prices of these companies over the last 10 years. Republic Services (the green line) saw its share price triple. Becton (black line) jumped 175%. Iron Mountain (blue line) gained 150%.

Just for good measure, that purple line is Berkshire Hathaway Class A shares (BRK.A), the price of which doubled over the past 10 years. And that sad red line at the bottom? That's the S&P 500 ($INX), which serves as the most common benchmark for the broader stock market. As too many retirees know all too well, the S&P 500 lost 20% over the last decade.

The takeaway: Over the last 10 years Warren Buffett beat the broader market by more than a hundred percentage points. Yes, there's a lot more to investing like Buffett than just doing some quick arithmetic with lines on a balance sheet, but book value per share is a very big deal to the Oracle of Omaha. Are you really going to argue with his results?