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Can Warren Buffett Save Bank of America?

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Yesterday, Warren Buffett saved America -- again. Or to be precise, he tried to save Bank of America (NYSE: BAC  ) , purchasing a sizable preferred stake in our eponymous bank and receiving a tidy 6% yield, plus a passel of cheap warrants in exchange.

As you've probably heard by now, the news set off a bit of a buying frenzy at B of A, whose shares were up as much as 25% at one point yesterday. They closed up just 9%, however, which gets this Fool to wondering: Was investors' initial Pavlovian reaction to the opening bell the right one? Can the mere fact that Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) has put $5 billion of its shareholders' cash behind B of A really save the bank?

Lessons from history
At least one analyst cast cold water on that hope yesterday. Specifically, the professors at opened up their history books and instructed students to examine the lesson of two of Buffett's other big bets on "stop the bleeding" stocks: General Electric (NYSE: GE  ) and Goldman Sachs (NYSE: GS  ) . Allow me to demonstrate:

Buffett Bought Preferred Shares of

Priced Initially at

Bottoming at

Now Worth

GE $25.50 $5.87 $15.65
Goldman $125.05 $47.41 $111.83

*Initial price is the closing price on the day of Buffett's investment. Bottom price is the lowest intraday price reached subsequently.

In the case of GE and GS, Buffett's investment that "stopped the bleeding" did indeed bring an immediate, and sharp, spike in the price of the shares affected -- but it didn't last long. Within six months of the Oracle's Sept. 30, 2008, investment in GE, for example, GE common shares had lost 77% of their value. Within just two months of his taking a preferred stake in Goldman (on Sept. 23, 2008), that stock bottomed down 62%. Most crucially, neither one of these stocks sells today for anything near what Buffett paid for them nearly three years ago.

Or as SI puts it: "Buffett got a sweet deal for himself" when he rode to the rescue of GE and GS. Unfortunately, "any common shareholder that would have followed him in would have been hurt badly."

Case closed?
Not quite. SI's right on the facts, of course. But the analyst neglects to mention two of Buffett's other Great Recession-era investments -- when the Oracle from Omaha chose to buy not stocks but bonds, from Harley-Davidson (NYSE: HOG  ) and USG (NYSE: USG  ) :

Buffett Bought Bonds From

Common Stock Sold for

Bottomed at

Now Worth

Harley $13.14 $7.99 $35.25
USG $7.07 $4.16 $8.35

As with the higher-profile bets on Goldman and GE, shares of both Harley and USG reacted positively to news of Buffett's support. As with Goldman and GE, Buffett's vote of confidence wasn't enough to keep the companies' shares rising in perpetuity. Unlike with investors in Goldman and GE, however, investors in Harley and USG did indeed manage to make a profit from following in Buffett's footprints.

Foolish takeaway
Now, I don't mean to be too hard on StreetInsider. The analyst there is correct to remind us that "monkey see Buffett, monkey do what Buffett's doing" is not a foolproof investing strategy. (Ahem! BYD Co. Cough-cough.)

Fact is, while Warren Buffett is a very smart man, and an ace investor, he's not an actual miracle worker. Sometimes his investments pay off. Sometimes they don't. Only time will tell for sure if Bank of America succeeds or fails -- but with the bank's shares selling for just one-third of book value, and barely five times next year's earnings, I think Buffett has the odds in his favor.

Want to watch how this investment works out? Add Bank of America to your watchlist.

Fool contributor Rich Smith does not own (or short) any company named above. The Motley Fool owns shares of Berkshire Hathaway and Bank of America. Motley Fool newsletter services have recommended buying shares of USG and Berkshire Hathaway. 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 (3) | Recommend This Article (11)

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 August 26, 2011, at 2:02 PM, prginww wrote:

    Wow, hope the MF police don't have your address or you're done mister! LOL Don't you know that we all follow in Buffet's footsteps?

  • Report this Comment On August 26, 2011, at 5:16 PM, prginww wrote:

    All BofA has to do is stay alive and Buffett earns 6% on his investment FOREVER. If the warrants should become valuable in the future, that's just icing on the cake. Keep in mind that if all BofA can do is pay Buffett his 6% then there is no income to spread around to the common stockholders so I wouldn't buy any common stock with the hope of getting a dividend in the near future.

  • Report this Comment On August 26, 2011, at 9:33 PM, prginww wrote:

    Buffett used a similar strategy--preferred convertibles--on Geico and AXP earlier, and anyone who followed him into those deals would have done very well by now. One thing we need to keep in mind is that Buffett has a very long time horizon (10 yr warrants for BAC) for his investments, so it's unfair to judge his success in a short time frame (or others who monkey him). For Buffett, it's an extremely low (or no) risk and high return investment because BAC is an incredibly cheap stock on a fundamental basis and he's covered on the downside regardless of how BAC performs. BAC was and still is dirt cheap: its global commercial banking and wealth management divisions (old Merril Lynch) alone had $45B in rev and $8B in profit in2010 (2009 numbers were even higher), a reasonable estimate would give it a market value anywhere between $60B and $100B, against a market cap of $70B for BAC; that means you pay a good price for those two divisions and get the #1 deposit base + mortgage business + card business thrown in for free. It's also cheap considering its pretax preprovision profit is $2.4 per share TTM, and its normalized earning power is nearly $2 per share after tax (or 3-4 x PE). Moynihan has been doing some right things, but turning around a ship as big as BAC takes time. Buffett's vote of confidene will surely help the management focus on the right things and ignore the market chatter. So given enough time, patient shareholders of BAc will be richly rewarded. Buffett will certainly be one of those. In the meantime, its share will fluctuate, just like everything else on the market. So if you want to follow Buffett into BAC, make sure 1) you understand its business and 2) you have a very long time horizon.

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10/26/2016 4:00 PM
BAC $16.87 Up +0.15 +0.90%
Bank of America CAPS Rating: ****
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Berkshire Hathaway… CAPS Rating: *****
BRK-B $143.94 Up +0.52 +0.36%
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GE $28.87 Up +0.22 +0.77%
General Electric CAPS Rating: ****
GS $177.07 Up +1.52 +0.87%
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HOG $56.55 Down -0.05 -0.09%
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USG $25.99 Up +0.11 +0.43%
USG CAPS Rating: ****