Buffett Would Go All In on This Company

You don't hear too many good things about banks these days, which is why those of us who traveled to the Berkshire Hathaway (NYSE: BRK-A  ) shareholder meeting over the weekend were taken aback when Warren Buffett gave the largest endorsement of a bank -- heck, of any company -- we've ever heard.

Recalling the days in early March when Wells Fargo (NYSE: WFC  ) slipped below $9 a share, Buffett -- without the slightest hesitation -- stated, "If I had to put all of my net worth into stock, that would be the stock."

Whoa!
Now, before you sell all your possessions and plow your net worth into Wells Fargo, realize that Buffett's comment was solely in respect to shares trading for less than $9 -- 63% below today's price. The incredible irony is that Buffett's net worth actually exceeded Wells Fargo's entire market cap at those depressed levels. (We'll let that inconsistency in his argument pass on the basis of sheer awesomeness.)

In any event, two big questions surround this rousing endorsement:

  • What does Buffett see in Wells Fargo that the rest of the market doesn't?
  • Are there any holes in his argument? Betting against Buffett is usually fruitless, but it's also dangerous to blindly chase anyone while oblivious to potential risks.

Here's a rundown of the good, bad, and ugly that Buffett has focused on in the past.

You can't touch this
Buffett recently told Fortune magazine that Wells Fargo's secret to success is "low-cost deposits and a lot of ancillary income coming in from their customer base."

Through a combination of reputational superiority and a sales force that's relentless about cross-selling new bank products, Wells Fargo has created a deposit base that's significantly cheaper than its competitors. Looking at 12-month CD rates, the difference between the rates at which Wells Fargo can raise deposits compared to those of its competitors is staggering:

Bank

Current 12-Month CD Rate

Wells Fargo

1.06%

Bank of America (NYSE: BAC  )

2%

Citigroup (NYSE: C  )

2.25%

JPMorgan Chase (NYSE: JPM  )

1.75%

*As of May 4, 2009.

Most importantly, that low-cost deposit base translates directly into earnings power. Looking at the net-interest margin -- the difference between a bank's interest income and interest expense -- Wells Fargo is in a league of its own:

Bank

2008 Net Interest Margin

Wells Fargo

4.8%

Bank of America

3%

Citigroup

3.1%

JPMorgan Chase

2.9%

Smarter than your average bank
Of course, a low-cost deposit bank means squat if you invest those deposits in firecrackers and lottery tickets. Bear Stearns and Lehman Brothers had exceptionally low costs of capital from exploiting the overnight repo market. How'd that end up working out?

It's hardly unscathed, but Wells Fargo nonetheless avoided most of the utterly insane lending practices that characterized the boom years. Rumor has it that the bank would often verify people's income before loaning money. Ingenious!

Nonetheless, one big area investors fret over is the book of assets Wells Fargo inherited from the Wachovia acquisition. Wachovia ultimately blew up because of its own 2006 acquisition of Golden West, which overdosed on variable-rate loans underwritten with standards that could make Bernie Madoff look like a wuss.

However, much of that risk has been purged from Wells' books, thanks to a 39% writedown of the high-risk portion of Wachovia's portfolio the day the merger closed. That's an insanely high number at which to discount a loan portfolio, and one that likely includes a nice margin of safety to protect Wells Fargo going forward. As Buffett recently noted, "...my guess is that the option ARMs will work out about as [Wells Fargo] guessed."

Great! So what's the catch?
All touting aside, are there any holes in Buffett's Wells Fargo love affair? Yes, one -- and it's actually a hole the Oracle himself pointed out a few months ago.

"The only worry," Buffet said back in March, "is that the government will force [banks] to sell shares at some terribly low price."

Well, start worrying. The Wall Street Journal reports that Wells will be among the handful of banks forced to recapitalize when the Treasury announces its stress test results this week. It's entirely unclear how much Wells will have to raise, but some estimates have tagged the number as high as $50 billion. Raising capital at low levels would be destructive for shareholders -- perhaps substantially so, if the Treasury overreacts in an attempt to cover its butt. And it probably will.

Bottom line
Just because Buffett seems fired up about a company's potential doesn't necessarily mean you should dive in headfirst. As we saw with Goldman Sachs (NYSE: GS  ) and General Electric (NYSE: GE  ) , he can get terms you and I couldn't dream about.

Even so, it's hard to look past this endorsement without acknowledging that good things come out of bad markets. When the world's most successful investor says he'd be comfortable making moves so bold, they'd normally classified as financial suicide, maybe it's time to listen.

For related Foolishness:

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Berkshire is a Motley Fool Stock Advisor pick, as well as a Motley Fool Inside Value selection. The Fool owns shares of Berkshire Hathaway; its disclosure policy prefers to spread its bets around.


Read/Post Comments (15) | Recommend This Article (51)

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 May 05, 2009, at 3:19 PM, catoismymotor wrote:

    It is one thing to say it. It is another thing to do it.

  • Report this Comment On May 05, 2009, at 5:17 PM, CAPTAINWACK wrote:

    Now your talking, he's a professional poker player.

    Let's see? Good old Warren has how many financial advisers? And this guy didn't know enough to cash out before the financial melt down? Thus saving himself and Berkshire investors billions.

    It's time to send Warren to the playboy mansion with a case of Viagra. Let him knock the socks off those hotties with his buddy. Get him off the streets before he hurts somebody.

  • Report this Comment On May 05, 2009, at 6:56 PM, FinancialFellow wrote:

    Warren's reputation for making smart decisions with Berkshire's money over the long haul is solid. There's a reason he became one of the richest men in the world so, I'm inclined to believe him when he says Wells Fargo is a good bet. As the article stated, though, he covered himself a bit when stipulating that his only concern is the government forcing dilution of shares. So, in essense what he's saying is that if shareholders don't get their ownership weakened as a result of the government's actions then Wells Fargo's stock is at a great price and over the long haul investors stand to do very well. Seems like a fair statement to me.

    The government involvement question is such an unknown, though, that it pretty much makes WF's current stock price seem less like a barain and more like a roll of the dice...

  • Report this Comment On May 06, 2009, at 9:55 AM, OleDrippy wrote:

    Pfft.. BFD... Who cares?

  • Report this Comment On May 06, 2009, at 10:36 AM, bullreturns wrote:

    Buffet's track record speaks for itself and that is the reason the street focuses on his every move.

    BUT....as the article above stated, WFC has one of the scariest mortgage portfolios imaginable. Wachovia paid top dollar for Golden West in 2006 at the absolute peak of the real estate market which led to the demise of Wachovia.

    At the time, Golden West had the largest option ARM portfolio. You know, those wonderful mortgages that have negative ammortization because the homeowner buys too much house and can't even afford the minimum interest payment and therefore pays whatever they can afford each month. What a great product!!!

    I like WFC, but those mortgages are $h*t and they will continue to blow up over the next few years and will therefore cause more potential write-downs.

  • Report this Comment On May 06, 2009, at 11:52 AM, PricePro12 wrote:

    Buffet is an exceptional man, but he is also just a man. To say you will follow his every move is not very smart considering the fact that the market is very unstable and overbought.

  • Report this Comment On May 06, 2009, at 1:02 PM, automaticaev wrote:

    was buffet working for minimum wage before his investments got him rich or was he pulling in 6+ figures a year? Seems relevent as to how good he is at investing. And to know if its worth it to follow his strategy.

  • Report this Comment On May 06, 2009, at 1:44 PM, PricePro12 wrote:

    Buffet is an amazing man full of life he has made his buck, and now he is trying to give back. Listen to the man. Market watch at Greenfaucet.com

  • Report this Comment On May 06, 2009, at 2:09 PM, TMFCrow wrote:

    @automaticaev

    Buffett made very little working for Ben Graham at Graham-Newman. He earned a handsome % of the profits while running the Buffett Partnerships, but only because they were so successful (he had a high hurdle). While at Berkshire he made $50k a year for a long time and now he makes $100k.

    I'd argue he's was underpaid prior to and after the partnership years. He certainly didn't get rich on his salary or on stock options. How many other CEOs can say the same?

  • Report this Comment On May 06, 2009, at 2:14 PM, automaticaev wrote:

    well anyone who made that much money could invest and get a ton of money.

  • Report this Comment On May 06, 2009, at 2:16 PM, automaticaev wrote:

    what % increase was on all the money he put in?

  • Report this Comment On May 06, 2009, at 2:20 PM, automaticaev wrote:

    if its like 2000% then he is grand.

  • Report this Comment On May 06, 2009, at 2:22 PM, automaticaev wrote:

    was it 2000% in 6 months is that why he is the greatest investor?

  • Report this Comment On July 07, 2009, at 8:18 AM, FriendyAnil wrote:

    Thanks for post. It’s really informative stuff.

    I really like to read.Hope to learn a lot and have a nice experience here! my best regards guys!

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  • Report this Comment On December 26, 2010, at 9:57 PM, VictoriaGia wrote:

    If I had a wish:

    Warren Buffet is fascinating, I wish to have the Honor of being in his Company for one week.

    I also would want to meet Bill Gates for one week!

    Donald Trump for one week!

    Barbara Corcoran for one week!

    Now that would be the ultimate

    Dream Come True!

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