Why Wells Fargo Is Warren Buffett’s Favorite Bank

Posted in Banking , Investments • December 5, 2012

warren buffett stocks

Wells Fargo & Company (WFC) is Warren Buffett’s favorite bank stock. Given Warren Buffett, chairman and CEO of Berkshire Hathaway (BRK-A, BRK-B), is widely considered the most successful investor of the 20th century, it’s smart for investors to pay attention to stocks he likes.

We’re going to dig a bit to find out why Buffett favors Wells Fargo. You may decide you, too, might want to invest in Wells Fargo. At the very least, you should gain some insight into Buffett’s stock-picking thought process.

Well Fargo: A Snapshot

Wells Fargo, based in San Francisco, provides retail, commercial and corporate banking services. It operates in three segments: Community Banking; Wholesale Banking; and Wealth, Brokerage & Retirement.

Warren Buffett Holdings

Wells Fargo is not only the largest bank stock position in Warren Buffett’s Berkshire-Hathaway, it’s his third largest overall public company holding (after #1 Coca-Cola and #2 IBM).

As of last summer, Buffett’s Berkshire owned 384,334,928 shares of Wells Fargo – a 7.44% stake in the company. This holding is valued at $12.59 billion, based on the stock’s closing price of $32.75 on Dec. 3.

What Makes Wells Fargo a Warren Buffett Stock?

Buffett is a value investor. In essence, a value investor’s goal is to buy stocks at less than their intrinsic values. Buffett’s take on value investing involves “finding an outstanding company at a sensible price” rather than a fair company at a bargain price. So, he’s not bottom-fishing for riskier stocks like some other value investors.

There are various methods to determine intrinsic value; some common valuation measures include Price-to-Earnings (P/E), Price-to-Earnings-to-Growth (PEG), Price-to-Cash Flow (P/CF), and Price-to-Book Value (P/BV).

The chart below contains select basic stock stats for both Wells Fargo and its major competitors/peers: Bank of America (BAC), Citigroup (C), and JPMorgan & Chase (JPM). I’ve included competitors’ stats as it’s important to look at a company in context.

WFC

BAC

C

JPM

Market Cap

171.5B

105.8B

100.2B

153.7B

Dividend Yield

2.7%

0.4%

0.1%

2.9%

P/E

10.2

26.5

14.4

8.6

PEG (5 yr expected)

1.33

2.97

0.72

1.21

Price/Book (mrq)

1.2

0.5

0.5

0.8

Profit Margin (ttm)

23.2%

6.8%

12.5%

22.0%

Qtrly Rev Growth (yoy)

10.1%

-25.5%

-35.7%

5.2%

Qtrly Earnings Growth (yoy)

21.8%

-94.5%

-87.6%

33.9%

Beta

1.16

1.77

1.85

1.65

(Source: Yahoo! Finance; mrq = most recent quarter, ttm = trailing twelve months, yoy = year over year)

Notable in the chart:

  • Dividend Yield – Wells Fargo has a solid (2.7%) dividend yield. Only one other company, JPM, has a solid (and very similar) dividend yield. Mature companies with more predictable earnings and cash flows often pay dividends.
  • Beta (last row) — Wells Fargo has the lowest beta of the four companies. Beta is a measure of stock price volatility. The stock market, as a whole, has a beta of 1.0. Wells Fargo’s beta means its stock price is just a little more volatile (about 16%) than the overall market. Financial stocks are often more volatile than the overall market. The other stocks are all considerably more volatile than the market: 77%, 85%, and 65% more. High beta stocks are not ‘Buffet type stocks.’
  • Profit Margin – Wells Fargo’s 23.2% margin is very solid. Only JPM has a similar margin.
  • PEG – There are many variables, but generally, a stock trading near a fair price will have a PEG around 1. Stocks that demonstrate more predicable earnings growth will usually be fairly valued at a PEG a bit higher than 1. Wells Fargo’s 1.33 PEG indicates it’s about fairly valued, perhaps a tad high. (Keep in mind when Buffett bought the stock, the price was lower — thus, the PEG was lower.)
  • P/BV – As similar to above, generally a stock trading near a fair price will have a P/BV of around 1 or a bit higher. BAC’s and C’s 0.5 ratios make them cheaply valued – but so cheaply valued high risk is indicated. (This valuation measure is best used on more physical asset-heavy industries such as manufacturers.)
  • Revenue & Earnings Growth – Wells Fargo’s revenue growth (10.1%) is the standout. JPM’s 5.2% is decent. Both Wells Fargo and JPM’s earnings growth were excellent last quarter. Meanwhile, the other two companies experienced huge drops in revenue and earnings. Of course, a more thorough analysis would look at longer-term growth rates, too.

Here’s a 1-year stock price performance chart for these stocks:

wells fargo

Wells Fargo is up 31%, Bank of America nearly 80%, Citigroup 27% and JPM 37%. Wells Fargo’s 31% is a great return — roughly twice that of the S&P 500. Granted, it’s not nearly as high as B of A’s return. However, B of A’s stock is springing back up only because it (along with Citigroup) had so deeply plunged in 2008-09 at the start of the financial crisis and Great Recession.

Note how much less volatile Wells Fargo stock price has been compared to the other three stocks, most notably B of A and Citigroup. Longer-term stock charts (not shown) show even larger differences in volatility.

It’s easy to see why Buffett likes Wells Fargo. It’s clearly the standout. Based on solely on our very basic analysis here, JPMorgan might look promising as a “Buffett stock” if its beta wasn’t so high.

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