Warren Buffett is famous for the strong track record he's put up for Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B). When you look at Buffett's holdings, you'll find that banking giant Wells Fargo (NYSE:WFC) is one of his largest positions, with more than $25 billion invested in the company. That amounts to almost 10% of Wells Fargo's outstanding shares, demonstrating Buffett's belief in the bank's prospects.
With Wells Fargo having gone through major controversies lately, some investors wonder whether the bank is a good value proposition or a potential trap. With that in mind, below we'll look at how Wells shapes up with Berkshire Hathaway on some key metrics that should tell you which one is a better buy for you.
Valuation and stock performance
In terms of recent performance, Berkshire Hathaway and Wells Fargo have been almost identical. Both stocks have produced a total return of 18% since August 2017, with Berkshire having the slightest of edges at less than half a percentage point.
Many investors like to establish valuations based on price-to-earnings ratios, but doing so with Berkshire Hathaway and Wells Fargo is a bit challenging. For Berkshire, the need to incorporate near-term movements into GAAP earnings leads to dramatic volatility. For instance, Berkshire's earnings multiple based on trailing earnings is only about 10, but based on near-term earnings projections, that figure rises above 20 on a forward basis. By contrast, Wells Fargo's trailing multiple of 15 is higher, but its forward multiple of 11 shows a less expensive valuation.
Book value is arguably a better way to compare values of these two companies. Berkshire currently sports a price-to-book of 1.46, which is a bit less than Wells Fargo's 1.58 figure. All told, Berkshire looks a little better on the valuation front, although the edge is fairly small at present.
Those who are familiar with Warren Buffett's stance on dividends know that this is no contest, as Berkshire Hathaway doesn't pay a dividend. Instead, Buffett argues that he can allocate his own capital to generate better returns than his shareholders could by receiving dividend income back. Some point to the mass of cash on Berkshire's balance sheet as an argument for the stock to start paying dividends, but it's unlikely that investors will see such a move in Buffett's lifetime. If anything, it's more likely that Berkshire will use stock buybacks to deploy excess capital.
Wells Fargo, on the other hand, has done well for dividend investors. A current yield of almost 3% reflects the 10% boost to its quarterly payout that the bank made last month. With that move, the dividend payment has more than made up for the temporary cuts that occurred during the financial crisis, and Wells now pays more than it did in the mid-2000s prior to the crisis.
With a solid commitment to paying income to shareholders, Wells Fargo is the only choice for dividend investors. Berkshire Hathaway isn't likely to join the ranks of dividend-paying stocks anytime soon.
Growth prospects and risks
Although both Berkshire and Wells are financial stocks, they operate in very different parts of the industry. In particular, Berkshire's investment holdings play a vital role in its performance, while Wells relies more on its own operational success.
For Berkshire, most of its key business metrics show solid signs of growth. In its most recent quarter, the company reported a 14% rise in insurance premium revenue, with an impressive $943 million underwriting profit showing the prowess with which Berkshire's insurance businesses obtain customers that are likely to have favorable claims experience from the insurer's perspective. Sales from its railroad, utility, and energy units climbed 11% from the year-ago period, and Berkshire also enjoyed dramatic benefits from the nearly 9 percentage point reduction in its effective tax rate that stemmed from the tax reform measures that passed in late 2017. With $111 billion in cash on its balance sheet, Berkshire has no shortage of funds available for making major acquisitions or investments should it choose to do so. But lately, finding attractive candidates has proven to be a challenge.
Wells Fargo is dealing with a more challenging situation. Adding to a long list of problems was August's revelation that a calculation error might have led to rejections of customer attempts to have mortgages modified in the aftermath of the financial crisis. Those rejections led to foreclosure in some cases, drawing even more ire from the general public in the wake of previous scandals involving unauthorized accounts, overcharges on mortgages, and improper auto-loan insurance billing. From a growth standpoint, the Federal Reserve's restriction on further asset growth could leave Wells struggling to compete against unfettered big-bank rivals that are moving forward dramatically to capture more business.
At this point, Wells Fargo's reputation has taken enough of a hit that its long-term performance is very much in question. Berkshire Hathaway offers a way to benefit if Wells does well while also providing diversified exposure across several industries. As a Berkshire shareholder, I'm much more comfortable with Buffett's approach right now and believe that Berkshire is the better buy.