It's no secret that Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) chairman and CEO Warren Buffett likes financial sector stocks. Of his 49 current holdings, roughly one-third are in the financial sector. Within the financial sector, Buffett favors banks, which represent roughly 15% of the overall portfolio.
Banks typically perform well in a rising interest rate environment because they earn a large portion of their revenue from interest on loans. But this is not a typical market, as rates are rising to fend off runaway inflation and the economy has slowed. This reflects the underperformance of many bank stocks relative to the S&P 500. But two Buffett bank stocks are positioned to outperform in this cycle.
1. US Bancorp
US Bancorp (USB 1.56%), the holding company for US Bank, is the fifth-largest bank in the country with about $577 billion in assets. It is also the ninth-largest holding in Buffett's portfolio, as his 126 million shares make up about 2.15% of the overall portfolio. The stock price is down 17% year to date as of June 22, which beats the S&P 500 and is better than any of the eight largest U.S. banks.
There are a few reasons why US Bancorp has done better than its peers -- and will continue to do so through this cycle. The primary reason is that US Bank derives more of its income from traditional banking services -- lending and deposits -- than other large banks. US Bancorp doesn't have the large investment banking or trading operations that the others have, which hurt it the past few years when merger and activity (M&A) activity was high. But now that M&A has slowed significantly, US Bancorp should benefit with its focus on lending.
The bank was able to increase its loans by 6.5% year over year in the first quarter and 3.4% over the fourth quarter of 2021. CFO Terry Dolan said on the first-quarter earnings call that loan growth is strong in the second quarter and should be throughout the year. The loan growth combined with rising interest rates and relatively low expenses should drive 5% to 7% revenue gains in 2022, he said.
What also helps US Bancorp is its excellent credit quality. Its ratio of nonperforming assets to loans and other real estate was 0.25% on March 31, down from 0.41% at the end of Q1 2021. Also, the net charge-off ratio was 2.1%, down from 3.1% a year ago, and Dolan said he expects it to remain below historic levels as the bank focuses on higher-quality loans through this cycle. This should limit credit losses.
Overall, the focus on lending, which represents a larger portion of revenue than it does for other large banks, buoyed by higher interest rates, should help US Bancorp outperform.
2. American Express
American Express (AXP 0.07%) is a credit card company, but it is also a bank that lends money to its card members for purchases, which they then pay back with interest. It is safe to say that Buffett loves American Express as he has held it since 1993, making it the second-longest-held stock currently in his portfolio, behind Coca-Cola. Not only that, but American Express is Buffett's third-largest current holding. He owns 151 million shares, which make up 7.8% of the entire portfolio.
American Express' stock price is down about 11.5% year to date, but the consensus estimate among analysts is that it will increase some 38% over the next 12 months to about $200 per share from its current $145.
Despite its negative return, American Express had an excellent first quarter with revenue up 29% year over year and card member spending climbing 35% year over year. The company added 3 million new proprietary cards in the quarter, as acquisitions of U.S. Consumer Platinum and Gold cards and U.S. Business Platinum cards reached all-time highs. It also had record monthly acquisitions for its Delta Airlines credit cards, reflecting a return of travel spending.
Travel and entertainment (T&E) spending makes up a sizable chunk of American Express' customer spending, and after two years of declines, there are signs that T&E spending is back. In the first quarter, T&E spending was at 88% of pre-pandemic levels, but that was due to a slower January and February because of the omicron variant of the coronavirus. In March, however, T&E spending returned to pre-pandemic levels for the first time and CEO Steve Squeri said on the first-quarter earnings call that he expects that to continue due to pent-up demand. In March, travel bookings on American Express cards were up 37% from before the pandemic.
While inflation remains high, American Express card members are typically more affluent and likely won't be as impacted. And the rising interest rates should boost interest income.
So, particularly now, these are two financial stocks that Buffett no doubt loves for their growth potential.
