Is This Warren Buffett Bank Stock Too Expensive?

There are two bank stocks in the 10 largest Berkshire Hathaway (BRK.A 0.99%) (BRK.B 0.91%) stock positions: Bank of America (BAC 2.06%) and US Bancorp (USB 1.48%). In this Fool Live video clip, recorded on Aug. 30, Fool.com contributors Matt Frankel, CFP, and Jason Hall discuss why they both ranked one of these stocks toward the bottom of Berkshire's top 10. 

Matt Frankel: No. 10, and I kind of like all 10 of these, but this was my No. 9 and your No. 10 was US Bancorp, so we'll start with that one. They are a similar bank in nature to like a Wells Fargo (WFC 1.24%). They are not an investment bank. They are purely a commercial banking operation. Aside from Wells Fargo, they're probably the biggest commercial-focused bank in the country. I want to say they are No. 5, actually, out of the banks. There's the big four; Wells Fargo, Bank of America, Citigroup (C 3.06%), and JPMorgan Chase (JPM 1.94%). Then there's a big gap, and then I think at No. five you have US Bancorp.

Jason Hall: Right. You're ranking them in size by total assets, right?

Frankel: By assets, I believe. I'm not sure if they're exactly five, but they're up there. But anyway, Buffett loves the banking business, but it's really not hard to see why this is one of the few that has made the cut. He recently turned back a lot of the bank positions in its portfolio. US Bancorp has an unparalleled history of responsible lending. Or say, out of all the big banks, they do the best job of maintaining high-quality assets. They pretty much avoided any financial crisis during the '08, '09 financial crisis. They are one of the few banks whose profits never went into the red. For an American bank, that's really not that common. My biggest hang-up and the reason I ranked it so low is valuation. The bank I could compare it to most, the closest in business model would be Wells Fargo. Wells Fargo trades at about little under 1.2 times its book value right now, US Bancorp trades for a little over 1.8 times its book value. Essentially, you're paying a 50% valuation premium over what I would consider its closest competitor in terms of business model. That's my hang-up on it. But I mean, like most bank stocks, you get what you pay for. You're paying a premium because it's a really well-run bank that has a great history of delivering. I ranked this No. 9, but the stock, at the right valuation, it would be my No. 1 or 2, but it's just I think valuation was my biggest obstacle.

Hall: Yeah. I think it's actually good that we're talking about valuation. Because in a lot of our services and a lot of the shows that, Matt, you and I both do, I don't want to say we're dismissive of valuation because we're certainly not. But we're focused on high-growth companies, often with smaller market caps or with massive potential addressable markets where valuation gets pushed a little further down the list. But when you're talking about something like these very large banks that are relatively predictable in terms of the earnings and the cash flows that they're capable of generating, valuation becomes far more important as a means of capturing above-average returns or ensuring that what you're going to get for your money is going to deliver the kind of return or the dividend yield or whatever you were looking to get. It really matters a lot more. But I came down for the exact same reasons as you with my ranking as well, because I think if you were to just focus on business quality for a commercial bank, yeah, this is particularly anyone that has more than a couple hundred billion in assets. There's not a lot that are anywhere close to the quality of this business.

Frankel: Yeah. I mean, I would call it the most quality bank of the 10 largest banks in the U.S. with the possible exception of JPMorgan Chase, which actually trades at a higher valuation.

Hall: But for reason, because you start looking at those return metrics like return on equity of 15%, I'm looking at it right now. They're almost 16% versus 15.8% return on equity for US Bancorp. Compare that to Wells, and it's been below 10% for some time, which 10%, that's like the benchmark where you want to be better than that. Then you look at return on assets and you're looking at, let's see, where is that US Bancorp at 1.34%. Again, the 1% is the goal there, and Wells is like 0.8%, and that's better because of all the troubles they've had, right?