Famed investor Warren Buffett hasn't been shy about his love for bank stocks in recent years. As a value investor, Buffett has probably been drawn to the low valuations at which large banks trade compared with the rest of the market. Yet out of all his bank holdings, Buffett appears to have particular affinity for Bank of America (NYSE:BAC), his largest bank holding and his second largest holding overall.
Though Wells Fargo (NYSE:WFC) had long been "Buffett's bank" after Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) bought a large stake in Wells during the 1989-1991 period, Bank of America surpassed Wells Fargo in the Buffett portfolio in 2018, as Buffett continued to increase an already large stake, while slightly decreasing his Wells Fargo stake to avoid exceeding a 10% ownership threshold.
Berkshire's holding in Bank of America dates to 2011, but Buffett has continued to add to that initial investment over the past two years. In fact, just two months ago, Buffett applied for permission from the Federal Reserve to increase his Bank of America stake to over 10% of the company, without the need for increased regulatory scrutiny -- a request he wasn't willing to make for the beleaguered Wells Fargo.
Clearly, Buffett loves Bank of America and its leadership under CEO Brian Moynihan. When you step back and look at how much money Buffett has already made off his Bank of America holdings, it's not hard to understand why.
A sweetheart deal
Buffett's first investment in Bank of America came in the form of preferred stock. Still reeling from the fallout of the 2008 financial crisis and the missteps of its former management, Bank of America found itself as a defendant in a hefty $10 billion lawsuit and thus found itself in need of capital. Enter Buffett, who in 2011 offered the bank $5 billion in the form of preferred stock, a type of security that's senior to the common equity but junior to a bond or note. Buffett's preferred shares yielded 6%, but even more important, they came with warrants to purchase 700,000 shares of Bank of America stock at a fixed price of $7.14 per share at any time over the following 10 years -- i.e., by 2021.
At the time, Buffett said of the Bank of America purchase:
At Bank of America, some huge mistakes were made by prior management. Brian Moynihan has made excellent progress in cleaning these up, though the completion of that process will take a number of years. Concurrently, he is nurturing a huge and attractive underlying business that will endure long after today's problems are forgotten. Our warrants to buy 700 million Bank of America shares will likely be of great value before they expire.
Swapping preferred for common
In 2017, upon passing an annual Federal Reserve stress test, the bank was given more latitude to raise its dividend. Management did so, increasing its annual dividend to $0.48 per share, above the $0.44 threshold that would have equaled the 6% yield Buffett was earning on his preferred shares. Since Buffett could receive a larger annual payout from Bank of America's then-current dividend than its preferred stock, Buffett swapped his preferred stock for 700 million common shares.
And Buffett continues adding
However, the 2017 conversion wasn't the end of the story for Buffett and Bank of America. During the course of 2018, Buffett increased his stake by over 30%, or $6.65 billion, at an average price of $30.34 -- bringing the total stake to 918.9 million shares, good for 9.5% of the company, at a cumulative average cost basis of $12.68.
But Buffett wasn't quite done just yet. When interest rates began falling in 2019 and U.S.-China trade negotiations turned south in the second quarter of 2019, bank stocks fell. Buffett struck again, increasing his stake by another $914 million, a 3.5% increase, at an average price of $29.42.
Add it all up...
The mid-2019 buy brought Buffett's grand total to 927.2 million shares, at an average cost of $13.55 per share and a total cost of $12.56 billion. At a current share price around $35, Buffett has made $19.89 billion in unrealized capital gains on his Bank of America holdings to date.
But wait -- there's more! Buffett has also received a hefty dose of dividend payments, both from his preferred stock and common equity. Buffett held his preferred shares from late 2011 to early 2017, so we can assume Berkshire received five and half years' worth of preferred dividends on the initial $5 billion invested, good for a total of $1.65 billion.
Then after swapping his preferred shares for common shares in 2017, Buffett received $0.24 per share in dividends during the second half of the year, good for another $168 million.
Over 2018, when Buffett was increasing his stake, Berkshire received another $0.54 per share in dividends. At an assumed average share count of 810 million shares, that's another $437 million.
Finally, in 2019, Berkshire will receive $0.66 per share in dividends. Assuming an average share count slightly below the current 927.2 million, that's good for another $605 million.
Drum roll, please...
Add it all up, and Buffett has received $19.89 billion in capital gains, plus $1.65 billion in preferred dividends, plus $1.21 billion in common dividends -- for a total of $22.75 billion.
Needless to say, a $22.75 billion profit on a $12.56 billion investment is a great result, representing a total gain of 181% in just eight years. That would equate to a 13.8% annualized return, but remember, some 35% of Buffett's stake was bought in just the past two years, so his average annual return is meaningfully higher than that.
Bank of America stock also hasn't had to perform any miracles to generate these returns; even after the stock's run higher, it only trades at 13 times earnings, still well below the P/E multiple of the overall market.
That's an incredible return for an investment in a very large, conservatively managed bank that had little possibility of permanent capital loss, and it's further evidence that Buffett is the greatest value investor of all time.