CEO Warren Buffett and his company Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) have long invested in bank stocks. Of the 10 top holdings in Berkshire's portfolio, four of them are banks. But as the coronavirus pandemic has struck the economy and the banking sector has been hit hard, Bank of America (BAC -0.13%) has emerged as Buffett's clear favorite among his bank stocks, and among his portfolio holdings. Here is what Bank of America means to Berkshire's portfolio.
How large is Berkshire's position?
The Oracle of Omaha seemed to go negative on bank stocks in the second quarter of the year, eliminating his position in Goldman Sachs (GS -0.23%), and significantly trimming his positions in other large banks like JPMorgan Chase (JPM 0.49%) and Wells Fargo (WFC -0.56%). Banks are closely linked to the economy, so Buffett's moves could be tied to his belief that the economy is going to suffer over the next several years, which is not an unreasonable view.
Image source: Bank of America.
But despite slashing a lot of his bank holdings in the second quarter, Buffett maintained his position in Bank of America. Then shortly after the second quarter ended, Berkshire pumped more than $2 billion into Bank of America over a two-week span. The company now owns almost 12% of Bank of America's outstanding shares, and has received approval from the Federal Reserve to purchase up to 24.9% of the bank's outstanding shares. That's certainly significant, because Buffett and Berkshire usually cap their purchases of banks at just below 10% of outstanding shares to avoid certain reporting requirements.
With more than 1.03 billion shares of Bank of America at an average price of $24.24 per share, Berkshire's total stake in Bank of America represents a market value of more than $25 billion. It's Berkshire's second-largest position in its more than $202 billion stock portfolio . That means it makes up more than 12% of Berkshire's portfolio, second only to Apple (AAPL 1.27%), which makes up nearly 60% of Berkshire's stock portfolio .
Impact on earnings
The $202 billion stock portfolio is just one part of Berkshire's roughly $788 billion balance sheet. The conglomerate also makes money through insurance, railroad, utilities, and energy business operations, among others. However, due to a new accounting rule in 2018, Berkshire Hathaway's gains and losses from its stock portfolio do flow through net earnings. The company, however, cautions on being too reliant on gains and losses from the stock portfolio because they are only on paper, reflecting changes of the market price of Berkshire's equity holdings, which can be extremely volatile, especially in the short term.
In the second quarter of 2020, Berkshire reported a profit of $26.4 billion, up more than 86% from the second quarter of 2019. However, through the first six months of the year, Berkshire reported a loss of $23.4 billion. That's because in the first quarter of the year, the company reported a loss of nearly $50 billion, and the bulk of that included after-tax losses of $54.5 billion on investments, primarily related to the decline in stocks.
A big chunk of this is likely attributed to the bank stocks that Berkshire holds, as the sector has taken a beating this year as a result of significant levels of expected future loan losses; low interest rates that will weigh down revenue; the complexity of analyzing banks; and economic uncertainty. Between the beginning of the year and the end of the second quarter, net gains on bank, insurance, and financial stocks that Berkshire owns declined from nearly $62 billion to about $28 billion. The fair value of those stocks declined from more than $102 billion to about $59 billion. Considering Bank of America's stock is down about 33% year to date and is the second-largest holding in Berkshire's stock portfolio, it has definitely played a big role in hurting Berkshire's net earnings in 2020.
Potential upside
Despite the struggles of the banking sector, Bank of America has held up relatively well in my opinion, given the circumstances. The bank has generated net income of more than $12 billion through the first three quarters of the year, despite adding $11.3 billion to total reserves for future potential loan losses. With Bank of America trading below book value, I believe the bank will have a greater and much more positive impact on future earnings for Berkshire Hathaway, despite the short-term problems it is experiencing now.
