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>>> Why Warren Buffett Is Big on Big Banks


By Andrew Bary

Nov. 23, 2018


https://www.barrons.com/articles/why-warren-buffett-is-big-on-big-banks-1543019299


Berkshire Hathaway CEO Warren Buffett is famous for having a good eye for value. These days, he has been looking hard at big U.S. banks.

Berkshire Hathaway (ticker: BRK.A) bought more than $13 billion of bank stocks in the third quarter, highlighted by a new, $4 billion holding in JPMorgan Chase (JPM) and an almost $6 billion purchase of Bank of America (BAC), the first major open-market buy by Berkshire.

Buffett’s company now holds stakes in seven of the country’s top 10 banks: Wells Fargo (WFC), U.S. Bancorp (USB), Goldman Sachs Group (GS), PNC Financial Services Group (PNC), and Bank of New York Mellon (BK), as well as JPMorgan and Bank of America. ( Citigroup (C), Morgan Stanley (MS), and Capital One Financial (COF) are the ones left out.)

“Buffett’s investments offer validation for what we see as the value in the group,” says Mike Mayo, a banking analyst with Wells Fargo. “Banks are less cyclical than they have been in decades and have more resilient earnings streams because of improved financial discipline and risk control.” He sees earnings growth of 50% or more for JPMorgan, Citigroup, and Bank of America over the next four years.

Buffett's Financial Exposure

How the major financial company holdings of Berkshire Hathaway stack up.

Company / Ticker
Shares Owned (mil)
Value (bil)
Shares Added* (mil)
Value of Shares Added** (mil)
Stake in Company

Bank of America / BAC 877 $23.9 198 $5,840 8.9%
Wells Fargo / WFC 442 23.1 -10 -507 9.4
American Express / AXP 152 16.1 0 0 17.7
U.S. Bancorp / USB 125 6.7 24 1,280 7.7
Bank of New York Mellon / BK 78 3.9 13 665 7.9
JPMorgan Chase / JPM 36 3.8 36 4,024 1.1
Goldman Sachs Group / GS 18 3.5 5 1,143 4.9
PNC Financial Services Group / PNC 6 0.8 6 829 1.3

TOTAL 82.0 13,274

Showing 1 to 9 of 9 entries
*Shares added in third quarter. **As of Sept. 30.

Investors don’t share Mayo’s—or Buffett’s—enthusiasm. Bank stocks have been weak on concerns about the global economy and slowing loan growth. The KBW index of 24 bank stocks is down 8% this year. Wells Fargo, led by CEO Timothy Sloan, and Citigroup are off about 15%. Goldman, the worst performer in the Dow Jones Industrial Average, is down 25%.

Buffett, who didn’t respond to a request for comment, may see what Mayo and other bulls do: a group that has lagged behind the market despite strong earnings growth and the most generous capital returns of any major industry.

Earnings at large banks are expected to rise about 40% this year. With income rising and stock prices generally lower, bank valuations have contracted. Large banks now have an average forward price/earnings ratio of just 10.2, against a forward P/E of 12.6 at the start of the year, based on 22 institutions covered by Barclays analyst Jason Goldberg.

“Investors can get good earnings growth and good capital returns at a discounted valuation relative to the overall market,” Goldberg says. “Just because we’re late in the cycle doesn’t mean we’re at the end of it.” He sees 9% growth in bank earnings per share in 2019.

John McDonald of Bernstein estimates that mid- and large-cap banks will return about 100% of their earnings to holders in dividends and buybacks in the year ending in June 2019, up from 60% in 2015.

Investors can play the group through any of the stocks favored by Buffett or via ETFs like Invesco KBW Bank (KBWB) or the broader Financial Select Sector SPDR (XLF); seven of its top 10 stocks are banks. Berkshire is the top holding.

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Mayo’s view is that a tougher regulatory regime may help keep banks out of any major trouble. “Bank investors should be sending holiday cards to regulators,” he says. “They’ve facilitated additional risk discipline in the industry.”

And while loan growth is slowing, it’s still rising in the low-single digits. The yield curve—the gap between long and short rates—has been narrowing, but banks are still reporting wider net interest margins.

With the seven big banks, a longstanding investment in American Express , and some smaller bank stakes, Berkshire’s financial-stock exposure is about $85 billion. That’s more than 40% of Berkshire’s total equity holdings of $200 billion—against a 14% weighting for the group in the S&P 500.

Buffett and his two investment lieutenants, Todd Combs and Ted Weschler, plowed money into stocks in the first three quarters of 2018, buying a net $24 billion of equities, versus $4 billion in the same period of 2017. The big stock purchases come as Buffett has failed to land a sizable acquisition.

The most intriguing stock purchase was JPMorgan. Buffett is a longtime fan of the bank’s CEO, Jamie Dimon, and Combs sits on the bank’s board. Buffett has said that he owned the stock personally and finally doubled down with Berkshire’s money.

With Berkshire owning just 1% of JPMorgan, there is plenty of room to build that stake. At $106.50 per share, it’s little changed this year and one of the best performers among major bank stocks. JPMorgan trades at a premium to much of the group with a 2018 P/E of 11.5, but below the market multiple of 16, and it has a dividend yield of 3%.

Goldberg has an Overweight rating and a $135 price target. He’s also a fan of Citigroup, which at $61.50 is the only major bank trading below tangible book value. His Citi rating is Overweight with a $93 price target. Goldman, at $189, trades just above its tangible book of $186 a share.

Barron’s recently wrote favorably on Bank of America, headed by CEO Brian Moynihan. Its strong deposit franchise and U.S.-focused consumer business give it one of the better earnings-growth outlooks among its peers. A bullish Mayo see the potential for $4 earnings per share in 2022, up more than 50% from this year’s expected $2.55. The stock trades at $27 and yields 2%.

Buffett isn’t always right, but he loves bank stocks. And that’s a pretty good endorsement.

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