8 Buffett Secrets for Investing in Banks

Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Warren Buffett is seen by many as one of the best investors of our time. But he's also often seen as particularly insightful when it comes to investing in banks.

Certainly Berkshire shareholders should hope that the latter is the case as the company owns 8% of banking giant Wells Fargo  (NYSE: WFC  ) along with $5 billion in Goldman Sachs  (NYSE: GS  ) , nearly $2 billion of US Bancorp  (NYSE: USB  ) stock, and roughly another $1 billion between M&T Bank  (NYSE: MTB  ) and Bank of New York Mellon  (NYSE: BK  ) . Not to mention $5 billion in preferred shares of Bank of America  (NYSE: BAC  ) .

So what does Warren know that makes him so prescient when it comes to banks?

1. Owning a bank can be a long-term endeavor.
The banking business is a cyclical one, but bank ownership for Buffett typically isn't. In 1969, Berkshire acquired Illinois National Bank and Trust Company and held onto it until it was forced by regulators to sell the bank in 1980. The company's ownership position in Wells Fargo goes back to 1989, while the stake in M&T Bank dates back to at least 1999.

2. Management matters.
We've seen from the financial crisis how reckless management can lead to outright disaster. When Buffett talks about the banks he's owned, he's generally taking time to praise management. Here's what he had to say in Berkshire's 1990 shareholder letter when praising Wells Fargo's management:

[The team at Wells Fargo pays] able people well, but abhor having a bigger head count than is needed... attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, [they] stick with what they understand and let their abilities, not their egos, determine what they attempt.

3. Leverage kills.
Again from the 1990 shareholder letter:

When assets are twenty times equity-a common ratio in this industry-mistakes that involve only a small portion of assets can destroy a major portion of equity. ... Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices.

4. Panic? Not a chance.
Rather than panic during banking downturns, Buffett has used them to build his ownership stakes. The original stake in Wells Fargo was purchased between late 1989 and early 1990 -- when banks were faltering during the previous banking crisis. During the latest meltdown, Buffett upped Berkshire's ownership in Wells Fargo and US Bancorp, maintained the company's position in M&T Bank, and famously provided preferred-share financing to Goldman. Just last year he sunk $5 billion into Bank of America when it was facing a market freak-out.

The fact that Wells Fargo's price fell after Berkshire initially bought didn't phase Buffett one bit:

Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices. Investors who expect to be ongoing buyers of investments throughout their lifetimes should adopt a similar attitude toward market fluctuations; instead many illogically become euphoric when stock prices rise and unhappy when they fall. 

In case you're wondering, yes, this is that classic Buffett "be greedy when others are fearful" sentiment.

5. Know where to look for performance.
As Marty Whitman puts it: "Rarely do more than three or four variables really count. Everything else is noise." 

Three things that Buffett has highlighted when it comes to evaluating a bank are: return on assets, risk (leverage ratio), and expenses (efficiency ratio).

6. Remember to own for a long time.
There's no reason to not mention this one twice, because it's an important one. To have a year where an attractive bank he owned made no profit "would not distress us." Instead, "at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity."

7. Pick your spots to go outside the box.
With all of this in mind (especially the risk part), Goldman Sachs may not seem like a very Buffett-esque bank to invest in. And it's really not. However, when we think about the investment banks that Berkshire could have invested in -- Bear Stearns, Lehman Brothers, Morgan Stanley  (NYSE: MS  ) , etc. -- Goldman stands out as head and shoulders above the rest.

Not to mention that Buffett was no stranger to Goldman. In Berkshire's 2003 shareholder letter, you can find Buffett singing the praises of -- believe it or not -- a Goldman Sachs investment banker:

I should add that Byron [Trott] has now been instrumental in three Berkshire acquisitions. He understands Berkshire far better than any investment banker with whom we have talked and – it hurts me to say this – earns his fee.

8. Don't get all mushy over the whole thing.
It's certainly possible to find great banks to invest in and Buffett has found his fair share for Berkshire. But banking ain't an easy slog, and even Buffett will admit he's not going out of his way for a bank unless it's really worthwhile. As he put it: "The banking business is no favorite of ours."

Buffett picks 'em, and you benefit
You can, of course, take the above points and use them to help you find great banks to invest in. Or, you could leave the picking to Warren and simply invest in Berkshire Hathaway. But is now the best time to be buying Berkshire? In The Motley Fool's premium report, Berkshire expert Joe Magyer shares his view on whether Berkshire is a buy right now. Click here to claim your copy of the report.

Read/Post Comments (11) | Recommend This Article (47)

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 November 29, 2012, at 1:55 PM, StopPrintinMoney wrote:

    Buffet's rule number one (the only one). Buy a huge bank before the sector collapses. Then sell your soul to the politics -- help the Treasury right (your) bank's bailout proposal and in exchange become a "rich don't pay enough taxes" Mascot. In the meanwhile, collect the taxpayers dollars and be a happy political whore.

  • Report this Comment On November 29, 2012, at 2:25 PM, TMFKopp wrote:


    As I'm sure you don't care (since you appear to be completely politically motivated), but other readers might, Buffett's investing in banks was taking place long before any of this tax stuff fired up.

    And, of course, the events of the past few years had little to do with Berkshire Hathaway transforming from a money-losing textile operation into a $200 billion conglomerate.


  • Report this Comment On November 29, 2012, at 9:52 PM, FooLawson wrote:

    Very true Kopp,

    What i see correlates is that Buffet has the same idea before an investment. A good company along with a fair price is the best opportune time to throw your money at the blood savages scraping the warehouse for penny's, and let them have a ball. Remember B of A being one of the too BIG to fail banks. If loads of money comes in and is allocated properly it will most definitely revamp the sector. (especially $5B)

    I had my doubts about B of A when I invested on 12/08/2011 (just before Buffet's acquisition). What really got me to invest was that I absolutely HATED Bank of America. Yet I have two bank accounts with them, as well as seven other accounts, but still. I am at nearly a 70% gain and I like to think i have similar ideas to Warren Buffet, hopefully I keep finding them before he does. 'I GOT EM'

  • Report this Comment On December 01, 2012, at 2:07 PM, Ardnassac wrote:

    This is especially true when you know the government will bail out the banks.

    According to the Economist, Buffet's success is that he waits for a blue chip to make a big error thus driving down the stock price then leveraging to purchase large blocks of the stock, thus driving it back up. He is able to leverage huge blocks of stock through his insurance business which the Economist claims is like getting a huge loan on 2%. Obviously, this is something that the average investor can't do.

    The other article that I read a while ago was that he invested in Fast Moving Consummables which are addicting - tobacco, coca cola, junk food etc..

  • Report this Comment On December 01, 2012, at 2:09 PM, Ardnassac wrote:

    It's interesting also that he stayed away from Citibank which I understand is one of the worst run banks ever, but didn't get involved in PNC which I understand is one of the best run banks.

  • Report this Comment On December 01, 2012, at 4:04 PM, veritasvincit wrote:

    I wonder what The Economist says about the inverse relationship between bitterness and knowledge.

    The idea that BRK leverages equity purchases or entire companies is, uh, debatable, especially when its balance sheet indicates $50 billion in cash.

    Buffett's philosophies are widely published, as are the details and record of his investments. He is quite generous with his money and with his wisdom. A casual visitor to the Berkshire Hathaway website will find a vast array of letters to shareholders, which are extraordinary and candid.

    Among that information is included his understanding that the enormous size of BRK actually hampers his ability to make meaningful deals.

    Every Fool has had the same opportunity as Buffett to buy common stocks, and, with little effort, gain access to corporate filings and balance sheets of public companies. Buying low and selling high is simple but not easy. Buffett is not unlike your mom; she told you to eat your vegetables and to go outside and play so you'll grow up to be big and strong. Pretty straightforward advice, but it sure hasn't hurt the diet pill or health club business.

  • Report this Comment On December 01, 2012, at 5:51 PM, commoncents33 wrote:

    Not sure why Buffett would be considered an expert on banks.

    He admitted he missed most of the huge bull market in banks from the 80's to the 90's.

    Then in 2008 he invested in two Irish banks, just before they tanked 90%.

  • Report this Comment On December 02, 2012, at 12:18 AM, TerryHogan wrote:

    I'm a big Buffett fan, but I agree with @commoncents33 that he's not necessarily a banking expert. I'd be willing to wager that if you asked him, he wouldn't call himself an expert at investing in banks either. He'd say he's good at capital allocation.


    Every Fool doesn't have anywhere near the same opportunity as Buffett. He's been getting sweetheart deals for years! Look at the preferred in Salomon, the preferred in GE, the preferred in GS, and countless other wholesale acquisitions that occured because of the Buffett brand and deep pockets. Yes we can buy common stocks like he can, but we don't have the same opportunities by a long shot. As far as the leverage issue goes, I think you're misunderstanding it. A lot of that cash you're talking about comes from insurance premiums which are essentially interest free loans from policy-holders that need to be paid back when claims are made (good underwriting makes them a little better than loans, but over 90% is generally returned) so in that since he's using leverage. Also, they've written huge put contracts which is basically more leverage.

  • Report this Comment On December 03, 2012, at 1:40 PM, Atlasher wrote:


    I'd more or less agree with the insurance premiums being interest free loans, but a certain amount of those premiums has to be kept on hand by law. They can't turn around and spend it all, but they certainly do profit from it!

    As far as BoA goes, it's also worth noting that Buffet didn't necessarily buy into the whole company. (This is all from memory, I hope the details aren't too askew). I believe he gave BoA a $5billion loan with the promise of 6% interest in return. I don't remember if there was a call date or expiration date. But getting $300 million a year from BoA sounds like a good deal! And if it happened that BoA went under, well Buffet owns preferred stock: He'll be getting his $5 billion back before any common stockholders see a dime.

  • Report this Comment On December 03, 2012, at 4:43 PM, sparksinchitown wrote:

    Soro's is a big tax guy who made a lot of money, why no thought pieces on him. Lot's to be made shortin america

  • Report this Comment On December 05, 2012, at 7:03 AM, ortho1g wrote:

    dont buy a bank that the gov forces bad loans

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