Over his several decades of investing, Warren Buffett has earned his position as one of the most successful investors of all time. Although the Oracle of Omaha does like to make big bets on his top picks, he has'ot limited himself to just one company in the financial sector.
Today, both Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC) make up major parts of Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) investment portfolio. But for average investors, the question is: Which bank is better for you?
Different companies, different investment styles
Followers of Buffett know that Wells Fargo has been a long-term Berkshire Hathaway investment and remains so today. Having gradually increased its stake over time, Berkshire Hathaway now owns over 463 million shares of Wells Fargo, or about 8.9% of the company.
The Bank of America investment followed a different route but found its way to becoming a major part of Buffett's portfolio nonetheless. As rumors swirled around the bank in 2011 and Wall Street wondered whether B of A would survive the year, Buffett made a strategic investment extracting terms no ordinary investors could get.
For a $5 billion investment, Berkshire would receive $5 billion in Bank of America preferred stock with a 6% cumulative dividend. And to give Berkshire a chance to benefit from Bank of America's recovery, Berkshire also received warrants to buy 700 million B of A shares at $7.14 each. Although the B of A investment was well timed for being greedy when others are fearful, Buffett noted in Berkshire's 2013 shareholder letter that the B of A investment was not going to be sold for a quick profit:
We are likely to purchase the shares just before expiration of our option. In the meantime, it is important for you to realize that Bank of America is, in effect, our fifth largest equity investment and one we value highly.
So Buffett has acquired sizable stakes in two major banks through two very different strategies. Now, let's look at the dividend aspect of his investments.
Dividends and income
Although Berkshire Hathaway itself doesn't pay a dividend, Buffett has long collected dividend-paying stocks to provide income for Berkshire. Today, Wells Fargo can be counted among the biggest dividend contributors to Berkshire's income, with Berkshire's stake earning around $650 million annually at the bank's current dividend rate.
Buffett has also managed to squeeze income out of Bank of America, with Berkshire's preferred stock earning $300 million in annual dividends. As an added sweetener to the investment, B of A has to pay a 5% premium to redeem the shares if it chooses to do so, something B of A agreed not to do for at least five years in exchange for making the dividend non-cumulative and therefore improving the bank's Tier 1 capital ratio.
But remember how Buffett made his investment in B of A on terms no ordinary investor could hope for? This is what allows Berkshire to collect a 6% dividend yield and get the upside of the stock through warrants. An ordinary investor would have to choose between B of A preferred stock that yields about 6% but has no common stock upside, or the common stock that yields only 1.3% even after the recent 400% dividend increase.
The yield Berkshire receives from its Wells Fargo stake corresponds to the yield on the common stock. which currently sits at 2.8%. While it's not a high yield, it's still more than twice that of Bank of America's common stock.
So for income and dividend investors, Wells Fargo has Bank of America beat hands down.
Warren Buffett is at home when it comes to value investing. He seeks out companies the market undervalues and adds them to Berkshire's portfolio before other investors react.
Deep value is probably what drove Buffett to Bank of America in 2011. With Wall Street in panic mode, Buffett could cut an impressive deal that saw him get both the yield and upside he wanted.
But today's Bank of America also looks undervalued, a factor that may be keeping it in Berkshire's portfolio. The bank trades at just over 1.0 times tangible book value while trading at 0.67 times book value. Traditionally, healthy major banks trade at a premium to book value, and even today's Wells Fargo trades at 1.46 times book value.
Bank of America's value has been held down as it has been dogged by lawsuits, many of which stemmed from its acquired Countrywide Financial unit. There is also limited trust on Wall Street for the bank, especially after the revealing of an accounting error forced the bank to rethink its capital return plan.
However, Bank of America still wins from the value investing side because of its sharp discount to book value in an industry where trading above book value is the norm. But B of A investors should be aware that this value pick does come with the additional risks of further lawsuits and legacy issues.
The best Buffett pick
Berkshire Hathaway's portfolio is now home to major holdings of two of the world's largest financial companies. With billions of dollars invested in both Wells Fargo and Bank of America, Buffett is clearly bullish on the future of both banks.
But which is better for you? Wells Fargo offers its growth potential alongside a 2.8% dividend and a track record of solid performance through the recent financial crisis. At the same time, Bank of America trades for only two-thirds of its book value and has the potential for significant capital appreciation if it can finally settle its legal and legacy issues.
But you don't have to choose just one. If both of these companies fit with your investment strategy, you could choose to follow Buffett and buy a piece of both.