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Better Buy: Berkshire Hathaway vs. Wells Fargo

By Brent Nyitray, CFA - Mar 27, 2020 at 11:40AM

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For one of these financial stocks, this is the best of times. For the other, it's the worst.

The current market environment is difficult for most sectors, and the financial sector is at ground zero. Despite lower interest rates and a Federal Reserve determined to maintain the plumbing of the financial markets, stocks across the sector have been subject to a "shoot first" mentality.

If you had to invest in one, which would you choose? Let's compare Berkshire Hathaway (BRK.A -0.59%) (BRK.B -0.29%) and Wells Fargo (WFC 2.31%) to see which is the better pick right now.

Berkshire Hathaway: Diversification pays

Warren Buffett's Berkshire Hathaway is an insurance company and a holding company with businesses in numerous sectors including utilities, energy, transportation, manufacturing, and finance.

While not perfect, it represents a diversified (if underinvested) portfolio. For Berkshire, this is finally a period where companies that it might consider for acquisition are finally priced right for a potential sale. The company has over $120 billion sitting in cash and short-term Treasuries earning little to nothing and waiting for an opportunity to be utilized. Berkshire stock has weathered the storm a little better than most, falling about 21% year to date.

insurance

Image source: Getty Images.

How will Berkshire Hathaway's businesses fare in the current economic situation? The insurance businesses it owns (and are its main revenue driver) will probably be reasonably stable. Perversely, GEICO may actually benefit from all this: With people stuck at home, there will probably be fewer accidents and fewer insurance claims in the short term. Property and casualty insurance claims are a function of natural disasters, not the economy. And COVID-19 probably isn't going to throw off the actuarial tables on life all too much, although the insurers will struggle to generate a decent return with prime interest rates hovering around zero again and sub-1% yielding Treasuries.

Berkshire's energy and utility businesses should be relatively stable; utilities are classic uber-conservative stocks that hold up despite broader economic fluctuations. The energy portion is largely pipelines and transport, so it should be relatively insensitive to volatile commodity prices at the moment. Berkshire's rail business will be economically sensitive, as will the manufacturing, building, and consumer businesses. 

Wells Fargo: The wrong place at the wrong time

Right now is not a good time for financials. The world is in the midst of one giant margin call, and asset values are getting hit while credit is tightening. This is an unambiguously horrid time to be a bank.

Wells Fargo (WFC 2.31%) is one of the biggest residential mortgage originators and servicers. Any sort of government-granted mortgage forbearance (temporary halts on foreclosure and lax mortgage payments) will hit Wells Fargo directly. Servicing assets will need to be written down, and many of Wells Fargo's mortgages will become delinquent. Commercial lending delinquencies are going to increase as small businesses cannot make rent payments, which means the developers can't make their mortgages. 

Wells Fargo's loan exposure is outlined in the table below. The company has $1.9 trillion in assets, of which about $1 trillion is the loan portfolio.

Asset Class Amount Percentage of Assets
Commercial and industrial loans $354 billion 18%
Commercial mortgages $121 billion 6%
Residential mortgages $323 billion 17%
Other consumer and commercial loans $162 billion 8%

Residential and commercial mortgages account for about 23% of Wells Fargo's assets. Nongovernment guaranteed mortgage-backed securities have been thrown overboard during the past two weeks on margin calls, and are trading (depending on the underlying assets and structure) anywhere from 60% of face value to 80%. Absolutely nothing, aside from government-backed paper, is trading at its proper value or above. While some of the issues are due to forced selling, credit losses are going to increase. Even agency real estate investment trusts (REIT), which invest in government-guaranteed mortgages, have not been immune to the pain because prepayment speeds are going to increase (via individuals refinancing at lower rates) and no amount of Federal Reserve support can change that fact.

Finally, mortgage servicing assets, of which Wells owns $11.5 billion worth, are getting cheaper by the day since they are one of the few assets out there that can become a liability in a bad recession. Unless the economy makes a miraculous recovery, Wells is going to be writing down some of these assets and will be increasing reserves, which will hit income. And while loans held to maturity may be somewhat immune from the daily volatility of the markets, persistent discounts in the market for comparable assets can't be ignored. Wells Fargo stock has been smashed year to date and is trading down about 46%. Like all of the companies in the financial sector, it is a falling knife at the moment.

This decision is easy

The financial sector is going through one of those times when everything is for sale, credit is getting tighter, and the economy is weakening. This is not the best time to be invested in banks. The time to buy bank stocks is once the writedowns are finished, and that part of the process hasn't even started yet.

For Berkshire Hathaway, some of its business lines will suffer, but the insurance business should be relatively immune from the chaos. This market, where there are numerous forced sellers and assets are being thrown overboard, is Warren Buffett's ideal investing environment. With over $120 billion in cash sitting on the balance sheet, he has dry powder and will get an opportunity to buy a great business on the cheap.

 

Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares) and short January 2021 $200 puts on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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Stocks Mentioned

Wells Fargo & Company Stock Quote
Wells Fargo & Company
WFC
$43.76 (2.31%) $0.99
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.A
$439,528.92 (-0.59%) $-2,620.08
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$292.07 (-0.29%) $0.84

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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