The Dividend Stock Warren Buffett Would Buy (if He Were You)

Really? Can I actually predict what stock the great Warren Buffett would buy if he were you?

Of course not. But I can see facts and patterns.

And from those facts and patterns, I've found a great dividend stock that matches up quite well with his current holdings.

Why doesn't he own it, then?
If you're an astute reader, you're probably asking this question -- if this is such a great stock, why doesn't Buffett own it himself?

The answer's simple. The company I've found has a market capitalization of $2.25 billion. That may seem pretty big, but it's chump change to Buffett's holding company -- Berkshire Hathaway (NYSE: BRK-B  ) (NYSE: BRK-A  ) . For it to make a splash, Buffett would have to buy the company outright -- and because of industry regulations, he can't do that.

Unless you happen to be a billionaire yourself, you don't have that problem.

Buffett would love to be you
At least from an opportunity standpoint, you and I have much better upside than Buffett. Because he's managing billions upon billions, he has to make deals like his purchase of Burlington Northern -- a huge railroad that he only expects reasonable returns on.

Reasonable returns aren't what we're used to getting from Buffett, but when you've beaten the tar out of the market for half a century, you just have too much capital to chase the small, underfollowed deals hiding in the corners of the market. How much is he hamstrung by his wealth? Here are Buffett's own words:

"It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."

Where to find those 50% returns
Of course, when Buffett first started out, he didn't generate 50%. No, he averaged more than 60% those first few years.

But that was before he was relegated to buying $40 billion companies whole. He could use his whole investing toolbox -- including taking advantage of the inefficiencies in the small-cap market.

Today, small-cap stocks are still underfollowed because they're too small for megainvestors like Buffett and Wall Street. And regular investors don't take the time to find them.  

Why Buffett would like this small stock
Looking at Buffett's current stock portfolio, we can see an area of the market he loves. More than 20% of his stock portfolio is split among three banks: Wells Fargo (NYSE: WFC  ) , US Bancorp (NYSE: USB  ) , and M&T Bank (NYSE: MTB  ) . In fact, Wells Fargo alone makes up about 17% of his portfolio.

Here's the thing, though. All of them look expensive at first glance. Banks selling at a price-to-tangible book value below 1.5 start getting attractive to me. But Wells trades at 2.1 and M&T trades at 2.7. Meanwhile, US Bancorp trades at 3.0!

This isn't a new thing. They're almost always at higher-than-average multiples. But Buffett holds throughout and adds on dips. He added more Wells Fargo in the third quarter when Wells averaged a multiple of 1.8.

Why is this?

It's because these banks are earnings machines. You may pay a lot for their book values, but they do a lot with them by cranking out returns on that book value that dwarf their competitors' returns.

The little bank I'm thinking of trades at similar multiples to the big boys, but dwarfs even their competitor-thumping returns.

The stock Buffett would buy if he could
What's this mighty little bank?

It's called Bank of Hawaii (NYSE: BOH  ) . Although it gets a decent amount of Wall Street coverage, its shares still fly under the radar of most investors. For every Bank of Hawaii share that's traded, 100 Wells Fargo shares are traded.

Bank of Hawaii trades at a price-to-tangible book value that's slightly higher than Wells Fargo's (2.3 vs. 2.1), but its return on equity is almost double (18.9% vs. 9.6%).

That return on equity advantage isn't a new phenomenon, either. And it's not the only impressive metric that Bank of Hawaii beats Wells Fargo on. B of H has historically high lending standards leading to a low percentage of bad loans (its bad loan percentage stands at just one-fifth the percentage of Wells Fargo's). And, once again, that's not a new phenomenon.

Top that off with a 3.8% dividend yield, and you have a stock Buffett would love. I'm not saying for sure that he'd be buying on dips, but based on his love of high-quality banks, I bet he'd at least strongly consider it.

Luckily for us, it's too small for him.

If banking doesn't excite you or if you're just looking for another Buffett-inspired stock idea, I invite you to read a free copy of our most recent Buffett report -- it details a health-care stock that he's been buying up. Click here to download it for free.

Anand Chokkavelu owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value and a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire Hathaway and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (21) | Recommend This Article (98)

Comments from our Foolish Readers

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 January 07, 2011, at 6:05 PM, Fundament wrote:

    As of today, I believe that Warren won't buy stocks from the financial sector again. GS was a specific turmoil. As of September 30, 2010, Warren’s portfolio had a 40.9 percent share within the financial sector. He sold MCO on the one hand and bought WFC on the other hand. Here is his latest portfolio and his movements in Q3/2010:

    http://long-term-investments.blogspot.com/2010/11/warren-buf...

    I believe that warren will invest more in the healthcare sector. Here is his investment participation very low (6.1 percent healthcare stocks). I think he will buy medical instrument companies like BDX or GE. Here is a sheet of high yield stock from the sector:

    http://long-term-investments.blogspot.com/2010/09/highest-di...

    The average dividend-yield amounts to 2.99 percent while the average P/E ratio is 15.98.

  • Report this Comment On January 07, 2011, at 6:35 PM, greenb95 wrote:

    Nah. If he were me, he'd want a better yield and higher earning's growth rate. A recent BUY for me: micro-cap tech stock WSTG.

  • Report this Comment On January 07, 2011, at 7:06 PM, kyith wrote:

    i wonder why Buffett will not be interested in MCD or Macdonalds. it is a favorite dividend aristocrat of many yet he doesn't make a move.

    Recently Macdonalds have been correcting >> http://www.investmentmoats.com/money-management/dividend-inv...

    Good time to make a move?

  • Report this Comment On January 08, 2011, at 12:48 AM, Merton123 wrote:

    Anand has brought our attention on a bank whose majority of the depositors reside in Hawaii. They have closed some of their branches in the outlying islands. Hawaii appears to be a mature market - (i.e., has already been developed). I don't see any catalyst and or economic trends which would indicate earning growth for this bank? I would have like to seen a little history about the bank, who are its main competitors, why does anand believe that this bank will grow, and will the growth be slow, medium, or hot. That type of analysis would give more of an incentive to subscribe to a newsletter versus saying that in Anand's opinion Warren Buffet would love this company and therefore we should invest in the company.

  • Report this Comment On January 08, 2011, at 5:56 PM, Merton123 wrote:

    Big is bad, and smaller is beautiful appears to be the sole reason to invest in Hawaii Bank. There are several local banks in Eastern Washington who are so small that they don't even trade on the pink sheets. You can invest in these local banks through a DRIP and they pay a very nice dividend. The Pro in buying these type of stocks is that they pay a lot more then a CD. The Con is that if you ever need the principal back you will have to find a buyer for your shares of stock. If you can own these shares in perpetuity you may make more money then a bond and the dividend receives special tax treatment versus a bond.

  • Report this Comment On January 08, 2011, at 6:19 PM, TMFBomb wrote:

    @Merton123,

    To dive in a little deeper on Bank of Hawaii, loan growth is a concern for management. While they've been growing deposits, they have had a harder time putting those deposits to work in loans...so they've had to use investment securities. That's a concern. But it would be more of a concern if they just made worse-quality loans...something many banks will do. And at the right buy-in price, I'm less concerned about stagnating growth.

    The health and growth of Bank of Hawaii is certainly tethered to the health of Hawaii's economy. In fact, in their earnings announcements, they included Hawaii economic stats like unemployment and tourism figures.

    For banks outside the really big banks that engage in investment banking, I do tend to rely on metrics more than I do in other industries. Why? Because their business models are pretty standard relative to other industries...they're not coming up with the next new computer chip...they're just taking in deposits and figuring out the best ways to invest those deposits...preferably with low-risk, higher-return loans. Also, I get some comfort out of the industry being regulated (despite shortfalls in the past).

    Back to why this is the type of company Buffett would be interested in if he didn't have as much money...the main reason is that it seems to run its operations very conservatively (evidenced by few bad loans and lots of provisioning for those bad loans), very efficiently (it spends little money on operations versus other banks), and very successfully (its returns on equity are absolutely amazing).

    To me, those are very compelling reasons to look further into the bank.

    Fool on,

    Anand

  • Report this Comment On January 08, 2011, at 9:11 PM, Merton123 wrote:

    I agree - thankyou Anand for following up on my questions.

  • Report this Comment On January 09, 2011, at 11:43 AM, Notfooled1 wrote:

    Andand, isn't it true that a stock increases in price as its earnings increase? True, Bank of Hawaii is an efficient operation, but where is there evidence of the likelihood of large earnings growth? I invested in WFC, GS, and GE in December, 2008, and have no regrets.

    Have you noticed that all of Buffet's selections had unlimited room to grow? Not true of BOH. There are many small caps more worthy than BOH, and I'm sure that you know it.

    Bomb, if BOH is not in your portfolio, why should it be in mine?

  • Report this Comment On January 09, 2011, at 4:35 PM, Merton123 wrote:

    Notfooled1 - actually Anand has made a very good selection if you read his response to my posting. BOH is unable to find enough people to loan money to so they are investing in the stock market. BOH is very similar in nature to Berkshire Hathaway who uses "float" (i.e., what people pay in premiums) to buy stocks. I wish that Anand was part of the team running Motley Fool American Fund - I would invest this year's Roth IRA money in a heartbeat in that fund if I knew that someone with Anand's touch was part of the team.

  • Report this Comment On January 09, 2011, at 6:03 PM, TMFBomb wrote:

    @Notfooled1,

    BOH is high on my watchlist of banks. I think it's a good candidate for purchase on dips. While I'd venture that it's a market outperformer at today's prices, I try to be extra vigilant about buying in at a great price for margin of safety reasons.

    -Anand

  • Report this Comment On January 09, 2011, at 7:55 PM, Merton123 wrote:

    BOH could become a "special situation". What happens if BOH has 4 billion in bonds and its market cap is 2 billion? A competitor could buy the business and make 100% profit. My expectation is that BOH doesn't want to become a take over target so they will convert their marketable securities into cash and declare a special dividend every so often. BOH is not a growth candidate but is instead a value play. The key is to monitor its marketable securities and determine about when they will declare the special dividend.

  • Report this Comment On January 10, 2011, at 1:25 AM, Merton123 wrote:

    BOH has 48,000 outstanding common stock and the rest is their treasury stock. This means that the bank controls the majority of the voting shares of the company. The net investment assets have doubled to $5,000,000 during the last two years which is in line with Anand's statement that the bank is investing in stocks and bonds since they can't find good risk loans customers. BOH can't be purchased by another bank since they retain majority control of the stock. The net investment assets may eventually dominate the balance sheet. Being able to unlock that treasure lode in an arbitrage type situtation is going to be difficult with the bank retaining majority control. Human nature being as it is - this treasure lode will become very tempting to the manager/owners of the company. BOH may start buying out other banks or pay their employees higher salaries. BOH must give up its treasury stock if it wants to start gobbling up other banks. That makes it a target for the larger fish. The managers of BOH in effect become the owners through the treasury stock. My expectation is that the pay arrangements will start to mirror the investment banks pay arrangements and the investment assets will be siphoned off my the manager/owner of the corporation.

  • Report this Comment On January 10, 2011, at 10:55 AM, JustEconist wrote:

    "Buffett would love to be you" !?

    No buffet convert information to money and I (and many of you like me) have almost zero information about stock market, policies etc compare to Buffet.

    Buffet mostly uses his connections to government (obama,Goldman sachs, JPM Daly) and industry (Bill Gate etc) to gain valuable information and buy/sell accordingly Not only that he can change government policies to his benefit (as he did when he lobbied for bank bail out so hard and as a result not only saved his huge share in Well Fargo but help to to grow much bigger)

    HOW DO I KNOW?

    From:

    http://wn.com/jim_cramer_explains_how_the_stock_market_is_ma...

    and all the other sources

  • Report this Comment On January 10, 2011, at 3:25 PM, Merton123 wrote:

    I looked up treasury stock and they don't have any voting rights, and also don't issue a dividend. BOH earnings are not growing, buts its Asset side of the balance sheet is growing because the bank is buying stocks and bonds (investment assets). I will go back to my original thesis that the bank will want to issue a special dividend to avoid becoming a takeover target by converting those assets into cash at some later point in time. The earning will probably be classified as extraordinary earnings on the P&L since the selling of investment assets occurs on an infrequent basis to provide the basis for the special dividend

  • Report this Comment On January 10, 2011, at 3:49 PM, Merton123 wrote:

    Anand - Could you help educate me by answering the following questions:

    1. What happens if BOH buys back all of its shares outstanding? Who are the owners of BOH? Does BOH continue to have a board of directors? Who has the final call?

    2. If we have the Asset Side of the Balance Sheet growing (i.e., investment assets appreciate) which results in an increase in Owner's Equity on the other side of the Balance Sheet, how does that translate into a higher stock price?

    3. If the investement assets on the balance sheet substantially appreciate in value does BOH become an attractive take over target. How does that work?

    Thankyou for your help and guidance :)

  • Report this Comment On January 11, 2011, at 12:23 PM, rpgizzle wrote:

    HCBK is a better play than BOH.

    Stock has performed better over the past 5 years

    Almost 1% higher dividend. Better profit margin, only major bank to not take a federal bailout, and lower price to book ratio.

    HCBK is a conservative bank like BOH as well.

  • Report this Comment On January 14, 2011, at 4:02 PM, jhbacon wrote:

    BOH up 4 1/2 % today. Good call Anand !

    Seems to make a lot of this discussion irrelevant. Day trades are not what we are all about, but, taking profits is.

    Jeff

  • Report this Comment On January 14, 2011, at 6:16 PM, sconcher wrote:

    Hawaii has the highest density of Millionaires per population in the US.

    http://www.bizjournals.com/pacific/stories/2009/07/13/daily1...

    http://finance.yahoo.com/real-estate/article/109083/the-rich...

    A potential investor can assume that BOH takes good care of these people and that their deposits end up in BOH vaults.

    I have No holdings in BOH.

  • Report this Comment On January 14, 2011, at 7:00 PM, kyith wrote:

    has the banks in US recover to healthy balance sheet levels since the crisis?

  • Report this Comment On January 15, 2011, at 11:51 AM, nottoosavvy wrote:

    This has been a very interesting learning lesson. I'm new to the money growing game. I have been buying CD's for years and my financial growth has suffered, so seeing other ways of financial growth is interesting and eye opening.

  • Report this Comment On January 15, 2011, at 6:17 PM, martystevens wrote:

    The initial analysis on this stock doesn't look so great plus I am skeptical about regional banks I don't know much about.

    For a quick snapshot on BOH's rating go to the link below from stock2own.com. This analysis is not favorable either.

    http://www.stock2own.com/StockAnalyzer.aspx?s=US:BOH

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