Historically speaking, Buffett and Munger’s holding company Berkshire Hathaway have consistently beaten the market, a very rare feat indeed. Since 1985, Berkshire Hathaway’s per-share book value has increased faster than the S&P 500 during every five years. The company boasts a compounded annual gain of 19.7% per year, compared to the market’s 9.4%, including dividends.
This is an incredible track record, and has earned Buffett such an enormous reputation that it almost seems fake, except it’s backed up by data. Research put forth by the National Bureau of Economic Research in regards to Buffett’s investing strategy tells us that he’s much more than just lucky. For the past 30 years, Buffett has managed to produce large returns without much risk.
Simply put, Buffett has achieved this accomplishment by following a simple strategy: Buy wonderful companies – or shares of wonderful companies – at a great price. Buffett’s decision-making process is based on the value investing paradigm, which he learned from David Dodd and Benjamin Graham at the Columbia Business School.
Small and large investors look to Buffett and his investing philosophy for guidance when it comes to making their own investment decisions. It’s not generally wise to play follow the leader, but it certainly doesn’t hurt to look at Buffett’s big investment decisions. We’ll now look at his largest stockholding, Wells Fargo.
1. Good company at a great price, or great company at a good price?
Buffett wrote in his 19 and letter to shareholders that, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” He was talking about “bargain purchase” mistakes, which is one of the value investing philosophy traps that is often quite difficult to avoid. In this same letter, he admits that he falls for this himself, and even highlights the purchase of the Berkshire textile manufacturing company. He said he was “enticed to buy because the price looked cheap,” but later went on to say that the deal was not a bargain after all.
“Now, when buying companies or common stocks,” wrote Buffett, “we look for first-class businesses accompanied by first-class managements.” He apparently means Wells Fargo. Buffett first purchase shares of this company in 1989, and for the last decade he has seriously added to the position. When he first purchased the shares, Buffett mentioned to Berkshire Hathaway shareholders that, “With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen.” Reichardt was the bank president from 1978 to 1984 and institution share until 1994. Hazen took over as president for Reichardt until 1998, and later became the chair until 2001.
By 1990, Buffett owned 5 million Wells Fargo stock shares that cost him $289.4 million. He’s bought at many different price points throughout this time, but his overall loss of heat seems to have stayed the same. He continuously adds to this position because he knows that Wells Fargo is one of the greatest banks in the industry run by the business’s best people. John Strumpf is currently at the helm of the banking conglomerate.
Buffett wrote in 1990 that, “Because leverage of 20:1 magnifies the effect 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.”
2. Some housing bets are smart bets.
The end of the 2000s was not the only time when the housing market was struggling. Back in 1990, Buffett wrote, “The markets major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion.” Both then and now, Wells Fargo was a leading lender for real estate, and as well, this exposure was a major record flag for a lot of investors.
Wells Fargo stock declined by 50% during 1990 because of the West Coast market fears. As I’m sure you can imagine, Buffett bought more. “We welcomed the decline because it allowed us to pick up many more shares at the new, panic prices,” he mentions to shareholders.
Some of the exact same thinking resurfaced when the housing market bubble burst, and Buffett repeatedly added to his Wells Fargo position. Buffett has bet big on the recovery of the housing market. In 2011, he said, “housing will come back – you can be sure of that.” Is there a better way to capitalize on the trend than owning a large chunk of the biggest retail mortgage lender in the US?
The exposure has come with a cost though. In December 2013, Wells Fargo made an announcement saying that they had to pay Fannie Mae $591 million in order to settle claims stating that they sold defective mortgages during the 2008 financial crisis.
3. The financial industry recovery is real.
Buffett is often looked at as a very different kind of investor than your typical Wall Street type. He has a well grounded common sense approach. He has an agreeable personality. When people speak of him, they do not typically mention Wall Street in the same breath. Buffett’s Wells Fargo stake, plus his large stake in other major banks clearly tell us what he thinks about the whole of the financial industry.
“The banks will not get this country in trouble,” said Buffett in early 2013 to Betty Liu of Bloomberg. “I guarantee it. The capital ratios are huge, the excesses on the asset side have been largely cleared out.” During this time, Buffett had multiple multibillion dollar investments in four of the seven largest lenders in the United States. “Our banking system is in the best shape in recent memory,” Buffett said the Bloomberg.
Buffett’s comments did not go unnoticed and without criticism. Many of the financial institutions were required to pay billions of dollars in order to settle lawsuits directly resulting from the crisis. Buffett made millions of dollars by dealing with the largest financial institutions. He made $2 billion on his deal from Goldman Sachs, and $5 billion from Bank of America.
While others were fearful, Buffett was greedy and became in the financial institution white knight throughout the crisis. This was a huge win for Berkshire Hathaway.
4. What it all means.
All in all, Buffett’s overall success comes down to the Wells Fargo stock price. On February 10, shares of Wells Fargo traded at $45.50, up roughly 28% on the year and about 50% over a two-year period. In the past five years, the stock is up 190%. The stock and the bank performed fairly well throughout the financial crisis and even the last 10 years, where only JP Morgan can really compare.
Analysts have a mean price at $49.01, and a median price of $50 for the stock. This represents a potential 10% upside.