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Berkshire Hathaway Likes Wells Fargo, UBS Likes Berkshire

By Alex Dumortier, CFA - Mar 28, 2016 at 11:30AM

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Wells Fargo has been one of Warren Buffett's best stock picks on behalf of Berkshire Hathaway, but UBS doesn't think his stock-picking ability is required for Berkshire to outperform.

Image source: DonkeyHotey, republished under CC BY 2.0.

U.S. equities are little changed following the Easter weekend. The S&P 500 (^GSPC 0.36%) and the Dow Jones Industrial Average (^DJI 0.00%) (DJINDICES: $INDU) are down 0.15% and 0.11%, respectively, at 11:20 a.m. ET on Monday. Shares of Warren Buffett's conglomerate, Berkshire Hathaway Inc., are outperforming the broad market, up 0.41%.

Bloomberg reported this morning that Berkshire is nearing the 10% ownership threshold with regard to San Francisco, Calif., lender Wells Fargo. The article says regulatory filings show that the financial-industrial conglomerate controlled 506 million shares at the end of 2015, or 9.9% of shares outstanding. Achieving the threshold would trigger a review by the bank's regulator, the Federal Reserve.

(The article does not provide a reference or a link to the regulatory filings in question. Berkshire Hathaway's latest form 13F, for Dec. 31, 2015, shows Berkshire's Wells Fargo stake amounts to 479.7 million. Bloomberg is in the business of financial data, so I'm going to give it the benefit of the doubt, here.)

Berkshire added shares of Wells Fargo, one of its "big four" equity positions, in 2015, but the creep toward the 10% threshold is also the result of share repurchases by the bank.

Berkshire came close to the threshold in 2007, but avoided breaching it as Wells Fargo issued shares to finance its purchases of Wachovia during the financial crisis.

Interestingly, Buffett also approached -- but was careful not to breach -- that threshold when he established his massive position back in 1990. In his 1990 letter to shareholders, he explained:

The exception was Wells Fargo, a superbly managed, high-return banking operation in which we increased our ownership to just under 10%, the most we can own without the approval of the Federal Reserve Board. About one-sixth of our position was bought in 1989, the rest in 1990.

The banking business is no favorite of ours. When assets are twenty times equity -- a common ratio in this industry -- mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks ... Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices.

With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen.

Separately, investment bank UBS initiated research on Berkshire Hathaway with a buy recommendation on Monday. UBS's Brian Meredith justified his call thusly:

We believe that the current uncertain economic and market environment plays into the hands of BRK, with its structural advantages of permanent capital, strong cash generation and industry-leading portfolio of businesses. This enables BRK to make acquisitions and/or invest in its operating units despite challenging environments, positioning it to grow earnings and book value faster than the S&P 500.

Furthermore, Meredith believes Buffett has built an enterprise with a culture and "structural advantages" that will enable it to continue outperforming after he disappears:

First, we believe that any Buffett premium built into BRK's shares has declined over time as Berkshire has shifted from an insurance and investment organization into a diversified conglomerate. Second, the structural advantages that exist today at the company will remain. Third, as a conglomerate of leading businesses, Berkshire has become much less reliant on Buffett's stock-picking skills to generate returns than it was in earlier years ... While Buffett's superior capital allocation skills and market "clout" would be missed, as long as the culture does not change, we would expect the company to continue to outperform.

At 1.3 times book value, per research service Morningstar, this Fool fully agrees with Meredith's call -- and his description of Berkshire's competitive position.

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