Buffett Likes Banks

When Warren Buffett speaks, the market listens. On Monday, in a three-hour interview on CNBC, Buffett had some good things to say about the banking sector. That was all the fuel that was needed for some of the bank stocks to take off:

Bank

Daily Return (03/09/2009)

Bank of America (NYSE: BAC  )

19.4%

Wells Fargo (NYSE: WFC  )

15.8%

US Bancorp (NYSE: USB  )

15.5%

SunTrust Banks (NYSE: STI  )

7.8%

BB&T (NYSE: BBT  )

4.1%

Some of the best gains were naturally reserved for stocks that Buffett owns on behalf of Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) : US Bancorp and Wells Fargo.

"Banking has never been better, in one sense."
Spelling out the reasons for his cheery disposition toward the sector in straightforward terms, Buffett said:

The banks are getting their money very cheaply, deposits are coming in, spreads have never been wider, all the new business they're doing is terrific. They will earn their way out of it [in the] overwhelming number of cases.

He went on to give specifics concerning Wells Fargo:

I would expect $40 billion a year pre-provision income. And under normal conditions I would expect maybe 10 to $12 billion a year of losses … So, you know, you get to very interesting figures.

What could Wells earn a few years out?
Those numbers are pretty close to the results that Wells put up last year (which don't include Wachovia), so I'm going to assume that Buffett was referring to Wells Fargo's earnings power without Wachovia.

Let's accept those numbers (using the upper bound for loan losses) and make the following assumptions:

  • Wachovia provides an incremental $3 billion in net income.
  • The merger achieves the announced $5 billion in cost savings.
  • Wells Fargo doesn't repay the government's $25 billion preferred share investment.

Under that scenario -- that of a normal operating environment -- I estimate that Wells Fargo could generate approximately $2.50 in earnings per share annually. Based on Monday's closing price of $9.97, that's equivalent to a price-to-earnings ratio of 4 -- pretty attractive!

Let's remember a couple of things, though: First, we aren't in a normal environment yet, and it's not clear how long it will take us to get there. Second, there is a reason that bank shares are trading at such depressed valuations. As Buffett pointed out:

"The only worry in that is the government will force you to sell shares at some terribly low price."
He went on to admit that forced dilution isn't an idle concern -- it's something that he himself thinks about. Furthermore, even the Oracle has been bitten by banks in this crisis. In 2008, he purchased $244 million worth of shares in two Irish banks, leaving him with an 89% loss at year's end. He gave himself a stern self-assessment on that situation during the interview: "I did not do my homework sufficiently on that, and I was just dead wrong."

Nonetheless, Berkshire is Wells Fargo's largest shareholder -- the position dates back to the last banking crisis in the early 1990s. In other words, Buffett's been doing his homework on Wells Fargo for a long time, and his degree of confidence should be much higher. I have to go with Buffett on this one: Despite my concerns about the California lender, I think it looks like a good bet right now.

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Alex Dumortier, CFA has a beneficial interest in Wells Fargo and BB&T, but not in any of the other companies mentioned in this article. BB&T is a Motley Fool Income Investor pick. Berkshire Hathaway is a Motley Fool Inside Value and a Motley Fool Stock Advisor recommendation. The Fool owns shares of Berkshire Hathaway. US Bancorp is a former Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days.The Motley Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (95)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 11, 2009, at 4:01 PM, bigkansasfool wrote:

    I think it's better to wait for him to actually buy, before diving in. Given WFC's TCE it is a real concern that the Fed will force WFC to raise a large amount of capital, which is what Buffett was inferring. The possibility of massive dilution, is a risk I'd take absent other risks, but that's not the situation WFC is in. I haven't seen any signs that housing prices are stabilizing or that defaults are stabilizing.

    Then another consideration of what Buffett said, was that he was depending on low interest rates. I don't remember the exact wording but he mentioned WFC's cost of funds and said "even I could make money with such a low cost of funds". I'm not as confident that interest rates will be low when WFC is finally not posting losses and having to raise its loan-loss reserves. Given the huge government spending right now, the Fed will have to be raising rates just as WFC is beginning to really recover.

    I think WFC is a value right now, just not the best place to allocate capital. There are so many business right now that are in much better shape and are being sold at similar or better discounts.

  • Report this Comment On March 11, 2009, at 6:00 PM, stphilip wrote:

    who cares what buffet says

  • Report this Comment On March 11, 2009, at 6:09 PM, JibJabs wrote:

    You missed one: MTB. He owns over 6 percent of the company. It is forever overlooked (full disclosure: I own stock in it).

  • Report this Comment On March 11, 2009, at 7:14 PM, TMFAleph1 wrote:

    stphilip,

    Thanks for your interest. Care to expand on your position?

  • Report this Comment On March 11, 2009, at 10:01 PM, skully201 wrote:

    Banks? Sun Trust because of the Coke stock; Regions because they have less than 1% of the CDO baloney to eat; and who knows?

    Let Mr. Buy and Hold Buffett buy banks. The market could use some upward pressure on some of the banks; any of them would do as long as they are big banks.

  • Report this Comment On March 12, 2009, at 6:28 AM, Dart65GTConv wrote:

    He's nuts, the banks have problems squared to ring out.

  • Report this Comment On March 12, 2009, at 7:58 AM, 7footmoose wrote:

    Mr Buffett has been right far more often than wrong over the past 50 years. That having been said, nothing like our current financial environment has occurred during the past 50 years. The banks have been clobbered and many of them deserved to be clobbered but others have suffered more than they deserve. If I were prescient I would know which are the great buys and which are the dogs. Some dogs do stand out in the crowd so we can all recognize them. Some of these banks will recover and prosper. Great management and an unwavering commitment to sound loan underwriting will differentiate the winners from the losers. If you are going to wade into this pool look first and very closely at the management team they will determine success or failure.

  • Report this Comment On March 12, 2009, at 8:16 AM, maxhoffa wrote:

    i'm long banks since last week, the doggy BAC, and the ultra UYG. will add WFC at the next tradeable dip.

    if i'm wrong, i'm out a decent vacation to hawaii. if i'm right, i just bought a new porsche at worst, a decent house at best.

    i'm just going to forget about these shares for a year or two at least.

    i don't see the feds nationalizing anything financial. even a weak recovery should bring these stocks back up 3x . . . a moderate to major recover, 5-10x.

    downside, sure, but i don't like hawaii all that much anyway when you get right down to it.

  • Report this Comment On March 12, 2009, at 8:19 AM, maxhoffa wrote:

    i'm long banks since last week, the doggy BAC, and the ultra UYG. will add WFC at the next tradeable dip.

    if i'm wrong, i'm out a decent vacation to hawaii. if i'm right, i just bought a new porsche at worst, a decent house at best.

    i'm just going to forget about these shares for a year or two or three.

    i don't see the feds nationalizing anything financial. i don't see them letting a major bank fail. even a weak recovery should bring these stocks back up 2-3x . . . a moderate to major recover, 5-10x.

    downside, sure, but i don't like hawaii all that much anyway when you get right down to it.

  • Report this Comment On March 12, 2009, at 8:20 AM, maxhoffa wrote:

    oops. my sony thinks it Y2K again or somethin'

  • Report this Comment On March 12, 2009, at 9:26 AM, howboutme wrote:

    Let me think about this: Its the day before the interview, my portfolio is down significantly and I dropped to second on the billionaire's list. I guess its time to use my financial wisdom (or my I'm so rich and in control that whatever I say will move the market voice) and talk about more of the stocks that I own so that Berkshire Hathaway can turn around and start going back up.

    Its obvious that the Banks are at the bottom, the only place left to go is out of business. The question is which one do you buy? Which one goes out of business? Don't forget that WB has a certain advantage, he does not buy stock like this poor sap, he buys an ageement of what he gets for putting money into a company. With that power, over time he can never loose, especially if he convinces the public to join in his quest.

    So, guess which bank will be let go by the government and you will win big in a couple of years. By what WB has and that should work, he won't let his go under!

  • Report this Comment On March 13, 2009, at 10:51 AM, meadowsll wrote:

    March 13, 2009

    To: Anybody influential over at Saturday Night Live

    I’d like to get in line for the $480 billion dollar reward for the best bail out plan that Secretary Timothy Geithner explained last week. .

    First Get some pig stys. Maybe one in each state. Except for two each in California and New York. Maybe a couple more in New York but not in New York City. I live here (Nimby = Not In My Backyard). Upstate somewhere but not too close to Albany. Those legislators are pretty gullible.

    Second Put all the recent and current financial CEOs and traders in the pig stys along with their toxic assets. At face value. Get some federal legislation that says those guys can’t go anywhere else for five years and their pay will be whatever they can wring out of their own toxic assets.

    Third Then the feds should put all the financial institutions’ good assets (especially my checking account with Citibank) into fresh new banks with new executives and computers. (Watch yourselves as you program those computers.)

    Fourth Use some of the bailout money to capitalize the new good banks. That means the government will be the stockholders of the new banks. (Everybody knows the current stockholders have been wiped out by the risks idiotically assumed and the exorbitant pay packages.)

    Fifth Hold the new bank stocks till things settle down a bit (say 2 or 3 years) then, when confidence has returned to the stock market, do one humongous IPO (that’s an Initial Public Offering). That’ll let you get rid of the responsibility before the new guys foul up.

    Just so you understand how public spirited I am, I offer you this wonderful plan without regard to whether or not I get the $480 billion. In other words, it’s an all or nothing deal. If I win, terrific. If not, well this only took me 17 minutes to write after my sugar-laden breakfast, it’s yours without charge. Okay, even without a credit. I’m serious here.

    In any event, thanks for listening while I blow off steam, cause I am steamed about the bailout.

  • Report this Comment On March 13, 2009, at 11:25 PM, trenton1ryan wrote:

    <He's nuts, the banks have problems squared to ring out.>

    I think this is what stphilip is getting at.

    Buffett is a smart man, but this swoon has shown that his magic lamp has gotten cloudy over the decades. The man knows biz and he knows balance sheets, but he's hardly going out on a limb buy suggesting banks are a good buy now.

    "I think what we're seeing is an entire economic reset."

    --Steve Ballymer

    Not a MSFT holder or Ballymer fan, but I think he's hit the nail on the head. There's much more pain ahead imo.

  • Report this Comment On March 15, 2009, at 1:45 PM, jayponce2000 wrote:

    i have been buying BAC, JPM and I will start buying WFC on a dip. Since I won't be paying taxes this year I will have plenty of cash. Why give it to the IRS. They'll just give it to AIG show they can pay out bonuses, I figured I just pay myself that bonus money to myself....I think we should all do the same, We can stimulate the ecomony....

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