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Warren Buffett's Favorite Bank Stock -- And Why It Could Be Worth a Look Now

By Matthew Frankel, CFP® and Jason Hall – Sep 8, 2021 at 6:41AM

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Here's a Buffett stock that two of our contributors both love.

In a recent episode of The Rank, longtime Fool.com contributors Matt Frankel, CFP, and Jason Hall ranked the 10 largest stock holdings in Berkshire Hathaway's (BRK.A -0.05%) (BRK.B 0.03%) portfolio -- and agreed on which one is the best buy now.  In this clip, recorded on Aug. 30, both experts explain why Bank of America (BAC -0.95%) was their No. 1 pick.

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Matt Frankel: This was both of our No. 1, I was happy to see we agreed on this. One of my personal largest stock positions, it's Bank of America, ticker symbol is BAC. Jason, I don't know if you know the story of how Buffett came to be a big stockholder in Bank of America.

Jason Hall: Yeah. Buying the debt, right?

Frankel: Right, so Buffett's Bank of America investment is one of the perfect example of why when people say, "How do I invest like Warren Buffett?" My response is, "You can't." This is a deal that no one else could have gotten. Shortly after the financial crisis, I want to say it was 2010 when this happened.

Hall: I know it was after a Moynihan had taken over as CEO.

Frankel: Right. He loved Brian Moynihan, he loved the bank's turnaround potential. He invested $5 billion in Bank of America preferred stock.

Hall: It was preferred stock or warrants?

Frankel: Preferred stock, paid a 6% annual dividend. $5 billion, it was paying $300 million in annual income to Berkshire. That didn't exist for any other shareholder at the moment. Not only that, but they gave Buffett warrants to buy 700 million shares at a share price of, I want to say it was $7.14. I think I remember that exact figure. Buffett kept these warrants in his back pocket, collected the $300 million in income from his preferred stock. He said when the time was getting close, he said as soon as Bank of America's dividend exceeds the $300 million, I'm getting in preferred stock income, that's when I'm going to exercise my warrants and convert that $5 billion investment into common stock. Berkshire's cost basis in those first 700 million shares is $5 billion. Before he converted the stock, they made a few billion dollars off of just preferred stock dividends, then they converted it to the common stock. The whole time Buffett said Bank of America will be one of our largest investments. Once we exercise those warrants, it'll be one of our largest investments and it's one that we value very highly. The last few years have really shown that because he's paired back most of his other bank holdings and added to Bank of America. Now, Berkshire owns more than 1 billion shares of Bank of America, owns 12.3% of the company. Requested to the, I think it was the SEC. They requested special permission to own more than 10% of a bank which you need special permission for. It's clearly, Warren Buffett's favorite bank stock and it's mine, too.

Hall: I'm going to share a screen here. This just shows the stock price roughly because it was October 2010, I think, is when we found out about the deal. The stock at the time was above $10 a share, then there was this decline right here. But at this point when it was already there, Berkshire had warrants that converted at $7.14 a share. It was just an incredible, incredible deal. But the key is, some of the other deals that Buffett has been able to get. Companies were going to pay the Buffett premium to have his name associated and that confidence in the business associated. For me, the reason it's my favorite bank is, Moynihan's done such an incredible job of simplifying, cleaning up the business, removing a lot of the risk and leveraging what they're really good at, which is taking just dirt cheap capital that they get and all of those deposits, and generating steady strong returns, improving the return profile. It trades for a reasonable valuation.

Frankel: Yeah, it's one of the more attractively valued bank stocks. It trades for little under 1.4 times book. If you remember back from U.S. Bancorp, they trade a little bit over 1.8 times book. I think Bank of America, they have a great cost of capital structure. They have perhaps the most to gain out of any of the banks from interest rates rising. They have the biggest proportion of non-interest bearing deposits. Meaning that if interest rates rise, the amount that they'll collect on things like auto loans, and mortgages, and personal loans, that'll go up as interest rates rise, but they're not paying any more interest on those deposits. The profit margin expands just a lot quicker than most banks that have to raise deposit interest rates proportionately as interest rates rise. All banks have some non-interest deposits, Bank of America just has the biggest proportion, which is why I like it at the current low interest environment we're in. I think they have the most to gain as interest rates rise.

Bank of America is an advertising partner of The Ascent, a Motley Fool company. Matthew Frankel, CFP owns shares of Bank of America and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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Stocks Mentioned

Bank of America Stock Quote
Bank of America
BAC
$37.34 (-0.95%) $0.36
Berkshire Hathaway (A shares) Stock Quote
Berkshire Hathaway (A shares)
BRK.A
$478,422.24 (-0.05%) $-253.31
Berkshire Hathaway (B shares) Stock Quote
Berkshire Hathaway (B shares)
BRK.B
$317.51 (0.03%) $0.08
US Bancorp Stock Quote
US Bancorp
USB
$43.88 (-0.85%) $0.38

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