Warren Buffett Is Betting $86 Billion on This Industry

Berkshire Hathaway (BRK.A -0.64%) (BRK.B -0.59%) recently revealed the contents of its closely watched stock portfolio as of the third quarter, and to the surprise of many investors, the company spent an 11-figure sum on bank stocks. And not just one -- Berkshire either initiated positions or added to existing positions in six banks during that three-month period.

In all, Berkshire Hathaway's bank stocks, much of which were selected by CEO Warren Buffett himself, are worth more than $86 billion as of this writing. That translates to about 41% of the company's stock portfolio. With that in mind, here's a rundown of Berkshire's bank stocks and why Buffett loves the industry so much.

Image source: The Motley Fool.

Berkshire Hathaway's bank stocks

As of the end of the third quarter, Berkshire Hathaway's stock portfolio contains 10 different bank stocks with a total market value of more than $86 billion as of this writing. And more than $13 billion of bank stocks were purchased during the quarter. Here they are in descending order based on the value of Berkshire's investment:

Data source: Berkshire Hathaway 13-F.

Why Buffett loves the banking business

There are a couple of main reasons Buffett is a fan of the banking industry. First, he loves to invest in "forever" businesses -- that is, businesses that will be needed decades and even centuries from now. And people will always need secure places to store and borrow money.

Second, there are some key parallels between banking and another Buffett favorite, the insurance business -- particularly in how they fund operations. Banks take in deposits, generally at little or no cost to them. They then lend out this money at substantially higher rates than they pay. In other words, banks primarily make their profits from other people's money, not their own.

Why so many banks?

The obvious reason Buffett has decided to own so many different bank stocks in Berkshire's portfolio is for diversification. Buffett loves the banking industry but may be hesitant to have too much of Berkshire's capital invested in any single bank.

The other big reason is that if Berkshire owns more than 10% of a bank, it can trigger a regulatory nightmare. (Berkshire has special permission from the Federal Reserve to own up to 25% of American Express.)

You'll notice that Berkshire's two largest bank investments -- Bank of America and Wells Fargo -- are both just under the 10% ownership threshold. Because both of these banks are buying back shares aggressively, Berkshire prefers to maintain its stake at significantly less than 10%, as its percentage ownership will increase over time as a result of these buybacks. Plus, Berkshire's investments in U.S. Bancorp and Bank of New York Mellon are getting close to the 10% ballpark as well.

And keep in mind that Berkshire is a half-trillion-dollar company. To move the needle, Berkshire needs to invest billions of dollars in an opportunity. That's probably why Berkshire added JPMorgan Chase to its portfolio during the third quarter. Berkshire could potentially invest more than $30 billion in the bank without getting too close to the 10% threshold.

In a nutshell, the combination of the 10% ownership regulatory threshold and the need to invest billions of dollars to have a meaningful impact is the reason Berkshire has to own large stakes in several big banks -- as opposed to, say, buying 50% of one of them.

Why is Buffett betting $86 billion on banks now?

As I mentioned, Buffett has been a fan of the banking industry for some time. For example, Wells Fargo and American Express have been staples in Berkshire's portfolio for decades.

However, Berkshire's recent bank stock investments seem especially aggressive, which indicates that Buffett sees considerable value in the industry.

While Buffett's precise reasons for choosing stocks are generally kept a secret, there are a few things we know for sure. For one thing, the financial sector has underperformed in 2018. While the S&P 500 is up 2.4% year to date, the financial sector has declined by nearly 4%.

And there are several positive catalysts fueling bank profits. As an example, banks were big beneficiaries of tax reform. The lower corporate tax rate has caused bank earnings to jump by 40% or more in many cases. Interest rates are another catalyst. Although the Federal Reserve has been increasing rates for some time, it hasn't translated into as much margin expansion for banks as experts had predicted, but that could change if longer-term interest rates begin to catch up.

In short, banks have a lot going for them, but you'd never know it by looking at their stock prices. Buffett loves bargains, so it's fair to assume that Buffett thinks bank stocks -- at least the six Berkshire recently bought -- are trading at a substantial discount to their intrinsic value.

Should you follow the Oracle of Omaha into his banking bets?

To be clear, it's never a smart idea to buy any stock simply because someone else did -- even if that someone else is Warren Buffett.

Having said that, the banking sector does appear to be on sale right now, and there are some stocks that look like especially good values. For example, Goldman Sachs, which Buffett bought more than 5 million shares of during the third quarter, looks like a tremendous value from a long-term perspective.

The bottom line is that Buffett has an eye for value, and the fact that he just invested more than $10 billion of Berkshire's capital in the banking industry when Berkshire was already overweight on the financial sector in its portfolio is a good indicator that the Oracle of Omaha sees some compelling bargains. And based on the valuations some bank stocks are trading for right now, it's tough to disagree.