Buffett Just Fired His Elephant Gun -- or Did He?

Berkshire Hathaway (BRK.A -0.43%) (BRK.B -0.28%) just made its first investment of the COVID era by purchasing the natural gas assets of Dominion (D 0.41%).

In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP discuss what investors need to know about it. In addition, hear about the latest efforts to force retailers to accept cash as a payment option and get the details on Wells Fargo's (WFC 0.21%) upcoming dividend cut. And finally, Frankel has his eye on Green Dot (GDOT 2.07%) while Moser is watching recent IPO Lemonade (LMND 6.68%) this week.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on July 6, 2020.

Jason Moser: It's Monday, July 6^th. I'm your host Jason Moser, joining me today is my financial partner-in-crime Certified Financial Planner, Matt Frankel. Matt, how's everything going?

Matt Frankel: Pretty good. It's a rainy day in South Carolina, but it was a beautiful weekend. Hopefully you had a nice 4^th of July out there.

Moser: Yeah, yeah. It was nice, it was hot, you know, but I mean everybody seemed like they really enjoyed themselves. My wife and kids got to go hang out at the pool in the neighborhood here for a while. I got some work done around the yard and stuff like that, did a little barbecuing, that was fun. It sounded like you had one of your specialties going this weekend, huh?

Frankel: Yeah, I'm a barbecue guy; I made a beef brisket. It's been a while since I've had enough people over to my house, because I don't know if you've seen a beef brisket, they're big cuts of meat.

Moser: [laughs] It's a lot of meat.

Frankel: So, it's been a while since I've had enough people over my house to justify making one. So, that was nice; it's always a big hit.

Moser: Yeah. You know, I was thinking about it over the weekend. I think that my favorite holiday, food-wise, is still Thanksgiving. But the 4^th of July holiday is usually a close second. We did a lot of good grilling, had a lot of good food. I do enjoy that summer cookout.

Frankel: Yeah, for sure. It's always a good time when you can bust out the grill and -- I don't know about you, I like cooking for a lot of people.

Moser: Yeah, well, yeah, I do too. I'm kind of the cook of the family, and I mean, it's just one of those things I have the ability to do and I enjoy it. So, it's one of those things I can do to contribute to the household. [laughs] But, yeah, I do like being able to cook for folks, so yeah.

Well on today's Financial show, we're going to take a look at Warren Buffett's latest firing of the elephant gun, could be a potential controversial investment here the Berkshire Hathaway is making for a lot of money. Big banks dividend is getting a little bit smaller it seems. As always, we have a couple of stocks for you to keep your eye on this week. But first off today, Matt, you know, this was something we read a few days back and it's not something, we had a release, it's not the first time we've seen this type of sentiment, but it does seem like something that's gaining some traction. There's a bipartisan Senate bill that's been introduced that would actually punish retailers for refusing cash payments.

Now, we talk about the War on Cash here all the time. I mean, when you look at some of these companies that are really leading that way, from the big ones, like MasterCard and Visa, smaller companies that are getting a lot bigger, PayPal, Square -- I mean, Square has been on fire here the past couple of weeks. We talk a lot about how, in particular, the pandemic, people have wanted to handle cash less and less. And there is science behind the fact that cash is pretty filthy. I mean, it does transmit germs. And so, it's understandable that people may not want to handle cash as much.

But this, the Payment Choice Act, which is something that's getting some traction here in the Senate, essentially they're saying that that's fine, the War on Cash is great, mobile payments, contactless, that's all fine, but you can't refuse using cash, you can't tell consumers that they can't use cash.

And I'd like to know your stance on this, because I think I know it, but what do you think about -- I mean, it's kind of weird this legislation has to exist, but by the same token, if I'm a merchant, I don't think I'd want to refuse any form of payment, I want to give my customers any which way to pay to ultimately make the sale. So, is this a legislation that really needs to exist?

Frankel: Well there's three points. One, like you said, it's just bad business to refuse cash. You know, you don't want to turn away customers that have [laughs] forms of legal currency. That's just a generally bad idea. No. 2, the purpose of the bill is to protect the people who don't have bank accounts. They call them the unbanked and the underbanked segment of the population. It's about 6% of the U.S. population and it skews toward minorities. African-American and Hispanics are a disproportionately large amount of that population. So, it's considered somewhat of a discriminatory act to refuse cash altogether. That's No. 2. And from a legal standpoint, it's written right on the money, this note is legal tender. It's really hard to make the argument toward refusing cash. That it's the one form of payment that is specifically -- you know, it's written on there, this is legal money in the United States of America.

So, I'm not surprised it has bipartisan support. Cash should have a place in our society. In a perfect world everybody would have access to a bank account, don't get me wrong. But cash should have some role in our financial system, at least for the time-being until we can figure out how to get digital payments reliably into everybody's hands.

Moser: Yeah. You make a good point there in regard to the unbanked and the underbanked, and I think the numbers that apply there. So, if you talk about actual unbanked, the FDIC [Federal Deposit Insurance Corporation] had a survey back in 2017 or '18, where they saw approximately 6.5% of Americans did not have a bank account at all. And then if you add underbanked to that equation, which is, you know, folks that need to resort to perhaps nontraditional methods to basically manage their financial lives, whether it's payday loans or something like that, the underbanked is essentially 25% of the population. So, there's a lot of people out there that don't have what we may see as a common, sort of, access to a bank account, a lot of people don't have that. So, you see the success of companies like Square with their cash app or PayPal, with PayPal and Venmo and Xoom and what not. I mean, it's sort of changing, maybe, that definition of what banking is in the 21^st century.

And I tend to agree with you, I feel like cash has a role in the economy. I'll give an example. I was over at Burke Nursery here over the weekend, it's a local nursery, and you know I was getting a bunch of mulch for a yard. And so, it's really great. You go in there, you just tell them what you want, then you pull your car around and they have a couple of guys come out and load it in the back of the car for you. And so, you know anytime I do that, I want to be able to tip those guys. I mean, they're doing hard work and it's out there it's hot, you know, I'll throw a couple of bucks their way. The only way I can do that is with cash. And so, until we get to a point where maybe you could disrupt that tipping mentality, in at least certain cases, I mean, any which way you cut it, it really does feel like cash is always going to have a place. And like you said, the language on the money says it plain as a day, like, [laughs] you have to accept it.

Frankel: Right. At some point, cash may be 1% or 2% of our transaction volume, I think right now it's something around a third, a third of transactions in America take place in cash. And it's generally lower dollar purchases. And I mean, I usually carry some cash, because if I'm buying something for $4 or something to that effect, I really don't want to use my credit card. But there's definitely a place for cash, and the cash use is just going to dwindle for the foreseeable future, but I don't see it going away anytime in the next few decades.

Moser: Yeah, I tend to agree. Interesting legislation nonetheless, the Payment Choice Act, I think that makes a lot of sense.

Well, hey, Matt, did you hear that? Did you hear that? That was the sound, the sound of Warren Buffett's elephant gun going off. [laughs] That was Warren Buffett's elephant gun, man, did you hear, you see this Berkshire Hathaway buying Dominion Energy natural gas assets ...

Frankel: ... Was it really the elephant gun?

Moser: Well, I guess, what was it, $4 billion transaction, the assumption of debt values the whole deal at $10 billion, I mean that's -- you know, I don't have $10 billion lying around on my couch. I mean, it seems like kind of a big deal, at least in relation to what he's not been doing lately, it is a big deal. It does strike me, I was a bit surprised -- I kind of -- I don't want to say a ho-hum, but this really does seem like a very Buffett-style investment, you know, investing in energy and natural gas. Talk to us a little bit about this. You follow Berkshire Hathaway, you write a lot about him and you know this company very well, explain this deal to me and to our listeners.

Frankel: Yeah, when I first saw the news about this yesterday, my first reaction was "Meh!" I'm not that excited about it, and I'd tell you why. One, you're right, $4 billion is a lot of money for pretty much every company but Berkshire Hathaway. Berkshire Hathaway ended the first quarter with $137 billion on its balance sheet, and that was before Buffett unloaded all the airline stocks and raised cash that way. So, $4 billion is kind of a drop in the bucket. And people were hoping he would take advantage of some sort of, you know, distress situation.

When you think back to the Great Recession era, coming out of the Great Recession Buffett invested in Goldman Sachs, Bank of America ...

Moser: GE, too, right? Didn't he invest in GE at that time?

Frankel: GE, but we don't talk about that. [laughs] I think he got out while the getting was still good. But you know, he got out of General Electric long ago. So, he made money off of it. But the point being, that during the crisis era, he invested in distressed companies, he did Buffett moves. And not only that, but the Bank of America and Goldman Sachs deals, those were investments that you and I couldn't have made.

If you remember the Bank of America deal, for example, he bought a bunch of warrants that gave him -- or he bought preferred stock, but it gave him the option of buying a bunch of common shares anytime within the next decade or so for, I think, $7/share. So, he quadrupled his money on that investment. Those securities didn't exist, they created them for Warren Buffett. Goldman Sachs was a similar deal too.

So, people were hoping for something similar like this. Maybe he would, you know, acquire a hotel chain that was going poorly or acquire some company that wasn't doing well. Dominion is doing fine, they're my power company, I know they're doing just fine. Dominion didn't need to sell its natural gas resources, if anything, its shareholders are kind of upset, because now they got a dividend cut out of the deal, you know, Dominion is going to have less income-producing resources to pay dividends with. They've already declared a dividend cut.

So, it does help -- I mean, utilities are a very Buffett business. They're pretty much guaranteed money. The only thing I really like about this deal is it adds to the margin of safety in Berkshire's cash flows, because utilities are money that are going to come in no matter what. People are always going to pay their electric bill; people are always going to pay their natural gas bill in this case. So, this increases Buffett's -- I think Berkshire has an 18% share of the natural gas pipeline business in the U.S. now after this deal, which makes him a pretty major player.

It's a pretty small deal, Berkshire-wise, it helps their utility business, it adds -- consistent cash flow is, in my opinion, the No. 1 perk of this deal, but it's not what a lot of his shareholders were hoping for, it's not likely to get a lot of people excited. People would be excited if Berkshire were to buy an airline that was about to go bankrupt and got it for pennies on the dollar or something like that. Because that would be a crisis-era Buffett investment that you would think of.

When you think back to the financial crisis, you don't think what utilities was Buffett looking at, you are thinking what banks did he invest in, what distressed companies did he buy. So, I don't hate the investment. That $4 billion will definitely be generating more revenue and more cash flow for shareholders than it would have sitting in Treasury securities. So, in that way it's definitely a good sign. But I still think Buffett is looking for that one COVID-era deal that's really going to, you know, live on through history, and this isn't it.

Moser: Yeah, I think you're right. I mean, it's a good point you make there, in that, whether it is energy/utilities or insurance, he really does have a penchant for those consistent cash flow businesses, right? The businesses that you know those payments are always coming in. I mean, those types of businesses can afford to take on a little bit of a different capital structure. They are able to handle more debt because they're so capital intensive, but also because they're so reliable. I mean, you know, your power bills are going to get paid for, insurance bills are going to get paid for. But, yeah, it does strike me as, well, I guess, it's OK. I mean, I'm not a Berkshire shareholder anymore, so I don't really care about it from that perspective, but yeah, it seems like we're waiting for some big, sexy acquisition and this just isn't it.

Frankel: Yeah. It could be coming, it could not be coming, but what I do like is that this, like you said, it's safe cash flow, it's going to generate more cash flow, so Berkshire's cash stockpile will grow even faster now. And it gives, the way I look at it, for every safe acquisition or investment Buffett makes like this, it gives him more wiggle room to make more stock purchases, more less-boring investments, if you will.

Moser: Well, yeah, take a position in, like, PagSeguro or StoneCo, I mean those are certainly smaller riskier ideas.

Frankel: Right. So, the more utilities; insurance companies, railroads, things like this you own, the easier it is to justify taking swings at that. So, I'm hoping this isn't the last of his 2020 investments. Remember I wrote the article at the beginning of the year, my 5 Bold Predictions. The only one that hasn't come true yet is Buffett will make a big acquisition and I'm not declaring it a victory today. I could take the easy victory lap, but I'm not going to, because I don't think this is a big Buffett-defining acquisition, I guess you could say.

Moser: I like that, man, hold to your standard, I can appreciate that, nothing wrong with that, Matt. Well, so in talking about Berkshire Hathaway, Warren Buffett, in related news, now Wells Fargo, which is clearly a very large Berkshire holding -- I mean, they've owned shares in Wells Fargo for a long, long time. We talked recently about the stress tests and these, sort of, worst-case scenarios where the Fed has looked to these banks, to say, listen, in the case of just the worst-case scenario, we could see some balance sheets and some capital positions here getting strained.

And so, there are some stipulations laid down in regard to share repurchases, in regard to dividends, but Wells Fargo, it looks like, is actually going to be cutting its dividend. Now, I don't think that's something that's going to happen maybe today, from what I can gather, the company reports earnings next week, on July 14^th, and that'll be for their second quarter. But it does sound like, for this third quarter, they're actually going to be, at the very least, cutting their dividend, I don't think they would eliminate it, do you?

Frankel: No. So, here's why they're going to cut their dividend. They've already announced they're going to have some sort of reduced payout, they haven't announced what it's going to be yet. So, Wells Fargo, as you know, is mostly a commercial bank, meaning that they don't have a giant investment banking operation, they make most of their money by taking in deposits and loaning out money. Because of that, they have a lot of exposure to potential losses if things go badly with this recession. So, during the first quarter, they built up their reserves by $3.1 billion, which reduced their earnings per share from, I think, $0.73/ share to $0.01/share. They didn't lose the money. They set this money aside in case the worst happens.

So, the Fed's recent action limits bank dividends to a formula based on their last four quarters of earnings. So, in the first quarter, Wells Fargo earned $0.01/share; that's obviously not helping its dividend. In the third and fourth quarter of last year, I have the numbers right in front of me. Wells Fargo earned $0.92 and $0.60 in the third and fourth quarters of last year. So, those are the three quarters we know so far. So, the bank also announced that it's going to be setting aside even more money in its loss reserves than it did during the first quarter, which pretty much means that it's going to have negative earnings in the second quarter when you factor that in.

So, doing the math, they had about $1.50/share in profit in the third and fourth quarter of last year, essentially nothing in the first quarter of this year. So, depending on what the profit they report in the second quarter of this year next week, they're going to be able to make a determination for their dividend going forward. It's not going to be enough to support the payout that they have.

Moser: No. And the stock has had a really tough year thus far. I think, essentially, year-to-date it's been cut-in-half already.

Frankel: Oh, Wells Fargo has had a very tough three years. Remember, Wells Fargo has been underperforming since before the pandemic was going on. It wasn't that long ago, I think in early 2016, Wells Fargo was considered the top-notch bank stock in America. All the scandals came out, so Wells Fargo is down something like 70% over the past few years, at a time, and the overall bank sector is up. So, they're by far the worst-performing bank stock out of the big four, including this year. So, Wells Fargo has been a real underperformer, their current dividend translated to something like an 8% yield. So, even if they're forced to cut their dividend in half, which I think is probably a pretty likely scenario, you're still looking at a 4% yielding bank stock. Wells Fargo's asset quality, it's pretty high quality, it's just that they have so much commercial banking exposure that in a worst-case scenario they are more prone to disaster.

Now, not that we think this is going to happen, the stress tests are designed to examine a scenario that's not really likely to happen. So, shareholders shouldn't panic. If anything, this could be potentially a buying opportunity on weakness. I'm hesitant to call any buying opportunity in Wells Fargo, just because of how it's gone the past few years, but I will say, the stock has got my attention in the past couple of months, I haven't pulled the trigger on it. But I'm not worried about it because of this dividend action, this is not a dividend cut in response to actual losses yet.

Moser: Yeah. Well, I mean, you know, you make a good point there. This is all based on some pretty simple math out there. I mean, obviously, Wells Fargo has had had some issues, but the fact that these banks are being held to these stress test standards, I mean, that's the whole point of this was to avoid the travesty and the carnage of what happened 10, 11 years ago, to avoid that happening again. And if they're running a tight ship, if things are going well, that dividend will come back. They maintain such a large presence in the mortgage market alone, I mean, this isn't a bank that can just go away.

We talk about in times when companies cut dividends, oftentimes it may sound like bad news, it sounds like a bad headline, but really, if you're forward-thinking, if you have a bit of a longer timeline, oftentimes that really actually is very good news, because that means the company is taking a look at its financial situation and trying to make sure they have all of their i's dotted and t's crossed.

Frankel: Yeah. And dividend cuts are not -- it depends on the circumstances; a proactive dividend cut can be a good thing. We're seeing a lot of that in the real estate sector this year. A lot of the real estate companies I follow are cutting dividends, especially hotel real estate, a lot of them are cutting dividends to preserve liquidity in anticipation of a worst-case scenario or something to that effect. So, something like that could be a net positive for shareholders long-term, or at least not a negative. You know, preserving liquidity is always a good thing or anticipation of a worst-case scenario, like Wells Fargo. It's a proactive dividend cut. It's not in response to an inability to pay, it's in response to what could happen down the road.

So, that's not necessarily a bad thing, what you don't want to see is a company forced to cut its dividend because it doesn't have any money. And those are the situations where it could be a runaway red flag situation.

Moser: And that's where you look at a company's financials, you look at that income statement, you can see that payout ratio, it's a clear-as-day metric. And the higher it is, the more you have to kind of wonder, can this company afford this type of dividend policy? It's one thing if it's a one-off, but if it's a sustained track record of a high dividend payout ratio, then I mean, you have to take that into consideration, no question about it.

Well, Matt, before we take off this week, let's give our listeners one to watch for the coming week. What is your one to watch this week?

Frankel: I'm going to bring back one of my old favorites, and I'm going to brag about it for just a minute. Green Dot, ticker symbol GDOT. I talked about Green Dot a long time ago. The stock got clobbered. They ended up making a major change, original Founder Steve Streit retired, we had him on the show a while ago, if you remember. He retired. They brought in a new CEO, Dan Henry, who's kind of a game-changing CEO for them. He's really prioritizing growth. He wants them to leverage their bank charter. He, kind of, really views their bank charter as the big differentiator between them and other prepaid card companies.

And this whole Wirecard scandal, if you've been following that, I'm sure you have been, you're the War on Cash guy. So, Wirecard, if you're not familiar, essentially $2 billion of cash evaporated from their balance sheet. So the Wirecard scandal could actually really play out to Green Dots advantage, especially being the payments company with a bank charter, because as you know, we follow companies like -- how long Square have been trying to get a bank charter for? So, having a bank charter in hand is a big differentiator right now, in a space that's getting crowded.

Green Dot has already doubled off of its lows, which I'm happy to say. For all the people who kept yelling at me about constantly talking about them, and it's finally starting to pan out a little bit. But I think there could be a lot more from here. Remember, they also have the Banking-as-a-Service business with customers like Apple, Uber, Intuit, and I think there's a lot more room on that side of the business too. They're a really unique company.

Moser: Absolutely. And what's the ticker on that?

Frankel: GDOT.

Moser: GDOT. Alright. Well, I am going to spend the week trying to learn a little bit more about a recent IPO, a lot of you probably have heard of this already. Lemonade, ticker is LMND. Interesting insurance play here. And going through their S-1, just to start getting a little bit more familiar with the business, their mission statement. Their mission is to harness technology and social impact to be the world's most-loved insurance company. And that alone, kind of, caught me, because I think a lot of people these days, you kind of think of insurance as like, nobody I think really loves their insurance company. I think most people just wish they didn't have to necessarily pay the bill or just hope that when they do have to file a claim that their insurance company [laughs] isn't going to screw them.

You know, maybe Lemonade sees a big opportunity there to really, kind of, change the narrative and the perception here. No question, it is geared toward a younger consumer, they are working on digitizing insurance from end-to-end. But it's also really interesting that their model, like a typical insurance company, they'll take those premiums in and then they'll, at some point or another, a catastrophe will happen and they'll have to pay out, and their profitability depends on that. Whether it's a pandemic or weather-related, whatever it may be.

It looks like Lemonade actually just -- they retain a fixed fee, about 25% of their premiums, and then ultimately pass off the insurance aspect of the business to third-party, basically they offload that business to reinsurers. So, I guess what they think they have at least is a little bit more consistency in the profitability, and, you know, utilizing technology really to attract perhaps a younger demographic. But new IPO, I mean, insurance is right up our alley here. I think I'd be a fun business to learn about, and maybe what we can do is we can try to take a week in the coming weeks here and do a deep-dive on the company for one of the shows here. But that's going to be the company I'm taking a look at this week.

So, listen, Matt, hey, you know, I'm glad you guys had a safe 4^th, it sounds like everybody is doing well down there. I appreciate you taking the time to join us today.

Frankel: Of course. Always good to be here.

Moser: Alrighty. That's going to do it for us this week, folks. Remember you can always reach out to us on Twitter @MFIndustryFocus. You can drop us an email at [email protected].

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

Today's show is produced by Tim Sparks. Thanks for making it happen, Tim, I appreciate you. From Matt Frankel, I'm Jason Moser, thanks for listening and we'll see you next week.