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If you know Warren Buffett then you know that his regular letter to shareholders each year never disappoints. That’s why wanted to share some of the most pertinent quotes with you today.

As I’m sure you recognize, Warren Buffett’s quite bullish on the United States of America in general and he has ignored lots of the negative news that we’ve been hearing as of late.

To quote Mr. Buffett:

“There was a lot of hand-wringing last year among CEOs who cried ‘uncertainty’ when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). At Berkshire, we didn’t share their fears, instead spending a record $9.8 billion on plant and equipment in 2012, about 88 percent of it in the United States.

“That’s 19 percent more than we spent in 2011, our previous high. Charlie and I love investing large sums in worthwhile projects, whatever the pundits are saying. We instead heed the words from Gary Allan’s new country song, ‘Every Storm Runs Out of Rain.’ We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America.”

Another Warren Buffett axiom is in regards to market timing. He doesn’t believe in it, but he does believe that there’s always an amount of uncertainty in all things investing. He finds it risky to not be invested in the stock market at this time. If you’ve been sitting on the sidelines for the last five years, then he feels that you made a mistake.

“A thought for my fellow CEOs: Of course, the immediate future is uncertain; America has faced the unknown since 1776,” said Mr Buffet. “It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful). American business will do fine over time. And, stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor  (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320 percent increase that materialised despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.)

“Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

Berkshire Hathaway’s core business model is its insurance operations. As always, Buffett made some very candid in Presley and comments in this regard. He said:

“If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit is earned, we enjoy the use of free money — and, better yet, get paid for holding it. That’s like you’re taking out a loan and having the bank pay you interest. Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss …. There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones.”

It’s been looked upon as rather odd when the insurance business talks about pricing discipline and underwriting. It often has a very poor track record in this regard. Mr. Buffett explains:

“There is very little ‘Berkshire-quality’ float existing in the insurance world. In 37 of the 45 years ending in 2011, the industry’s premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall return on tangible equity has for many decades fallen far short of the average return realized by American industry, a sorry performance almost certain to continue.”

Coincidentally, this matches up to a research report published back in September 2011 by Citigroup. They learn that from the years 1975 through 2010, the P/C industry only generated a total of five years worth of positive underwriting income. According to Keith Walsh’s report, over that five-year period there was a deficit of $457 billion.

Today’s yields will never be able to overcome or subsidize any losses of that magnitude today.

Warren Buffett clearly states that:

“A further unpleasant reality adds to the industry’s dim prospects: Insurance earnings are now benefiting from ‘legacy’ bond portfolios that deliver much higher yields than will be available when funds are reinvested during the next few years — and perhaps for many years beyond that. Today’s bond portfolios are, in effect, wasting assets. Earnings of insurers will be hurt in a significant way as bonds mature and are rolled over.”

The truth for the insurance business does not always apply to every firm. Some of these insurance companies have incredible track records, and they consistently earn underwriting profits. Berkshire Hathaway has done this for 10 years in a row. Warren Buffett gives some advice in his regular down-to-earth style:

“At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained.

“Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that is being eagerly written by their competitors. That old line, ‘The other guy is doing it, so we must as well,’ spells trouble in any business, but none more so than insurance.”

Warren Buffett also shared some words of wisdom in regards to the newspaper industry. Here’s what he had to share:

“Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town — whether the news is about the mayor or taxes or high school football — there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbours will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents … We do not believe that success will come from cutting either the news content or frequency of publication. Indeed, skimpy news coverage will almost certainly lead to skimpy readership. And the less-than-daily publication that is now being tried in some large towns or cities — while it may improve profits in the short term — seems certain to diminish the papers’ relevance over time.”

And here’s a few other quotes that are certainly worth repeating…

“More than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price. Despite the compelling logic of his position, I have sometimes reverted to my old habit of bargain-hunting, with results ranging from tolerable to terrible … Of course, a business with terrific economics can be a bad investment if the price paid is excessive.

“But wishing makes dreams come true only in Disney movies; it’s poison in business.”

If you haven’t read it already, you should grab a copy of Warren Buffett’s letter to shareholders. You can learn plenty from this financial genius. Reading his annual letters will help greatly enhance your financial acumen. The letter is certainly worthy of your time, effort and energy.

Warren Buffett and Berkshire Hathaway released their annual letter to shareholders last Friday. There were plenty of useful comments on a wide variety of topics revolving around investing, and this document will be a major part of the conversation of investors over the following weeks ahead.

Warren Buffett touched upon one area in his letter to shareholders revolving around the type of investment that very few investors have in their portfolio: stock options. Buffett has used options to boost the profits of Berkshire Hathaway, and in his shareholder letter, he talks about his belief that options can produce profits of a greater magnitude later on in the future. By making this claim, Warren Buffett calls into question if the entire open market for this type of investment is potentially mispriced – and it creates other opportunities for intelligent long-term investors.

Let’s now take a look into Buffett’s argument a little bit further, and overturn some stones by discussing ways to take advantage of this untapped opportunity.

The Big Bull Market Bet

During the years 2004 until 2008, Warren Buffett and Berkshire Hathaway took massive exposure upon themselves within the options market. They were selling put options on the major stock market benchmarks covering Europe, Japan, the UK and the US. By doing so, Berkshire Hathaway was extending its traditional insurance business to provide protection that is stock market related for its counterparties. Berkshire Hathaway brought in $4.2 billion by selling these put options, and just like the other premiums Berkshire receives from its insurance businesses, they turned around and invested these billions of dollars in sales into its stock holdings and operating companies.

When the market melted down in 2008 and throughout the early part of 2009, the put options looked like a really bad move. At the time, Berkshire Hathaway was sitting on what appeared to be a potential $10 billion loss, with the possibility that the losses would be even greater if the market stayed low past the options expiration dates, which range from the years 2018 through 2026. But at the time of this writing, the current intrinsic value of the options are now below the premiums Berkshire Hathaway received, thanks to the large bull market that’s happened over the last four years. Overall, Buffett expects the final amount due under the options to be a lot less than the current figure of $3.9 billion.

Is There a Flaw in Long-Term Option Pricing?

Brendan Conway of Barron’s posted a fantastic blog post last Friday afternoon, which reminded investors of Berkshire Hathaway of the history behind these Buffett puts. As commonly noted, Buffett has gone to tremendous lengths in one of his previous shareholder letters to describe the inefficiencies and pricing of the options market and how Buffett planned to exploit it.

The root of the options problem lies specifically in the volatility assumptions made in the very commonly used Black-Scholes formula. From year to year or day-to-day, stocks can move rather abruptly, and the assumptions of volatility often are baked into the price of options. But when you look at them over longer periods of time, stock market returns are much smoother, and Black-Scholes will value options more highly than it is actually appropriate – which makes them much better to sell instead of buy, and this is especially true when you have puts expecting the market to continue to trend upward.

Warren Buffett’s behavior points to a much different view toward trading options for the long term on the buy side. When Buffett has previously provided financing to large corporations like General Electric and Goldman Sachs, he used warrants that are options like, and they provide a long-term equity kicker to Berkshire Hathaway with this investment. By being willing to hold onto these warrants strongly points to Buffett’s belief that volatility on the downside is overestimated, then the upside volatility is also underestimated, which will make long-term call options the better buy for investors.

Can Anyone Take Advantage of This?

The short answer is no. The deals put together by Warren Buffett are not typically available to your average investor. The long-term options available to the public will normally only run just a few years into the future, but that is not a long enough time for an entire bull – bear cycle to run its course for reversion to the mean to take place.

The one place where long-term options are available at this time is in financial stocks. This is thanks to the TARP bailouts, so five to six year warrants are currently available from several major banks and other financial institutions. For Capital One and Hartford Financial, these warrants are already in the money – which means that the current price of the shares already exceeds the exercise price of the warrant. This will limit the impact of volatility estimate errors on the warrant price.

But on the other hand, Bank of America and Citigroup still have warrants where the strike prices are well above the share value at the current market price. With the bulk of the value coming from the time value and the estimates of volatility that are generated, the warrants for these shares are very susceptible to the type of mispricing that Warren Buffett is discussing.

Take a Look for Yourself

Remember that options and warrants are a very specialized type of investment and they present a substantial risk. But regardless, the questions revolved around proper pricing for the long term bring up the possibility that you can use this type of option to your advantage, which means you might want to take a closer look.

The long-term track record of Warren Buffett’s success has made him the best investor of our time, but currently Berkshire Hathaway shares are trading at their all-time high. Is it the right time to buy Berkshire right now? You decide.

Warren Buffett is a billionaire investor who has taken out stakes in some of the largest United States banks, who tells us that the lenders have rebuilt their capital to the levels where they aren’t a possible threat to the economy any longer.

“The banks will not get this country in trouble, I guarantee it,” said Buffett – the CEO and chairman of Berkshire Hathaway, based out of Omaha, Nebraska – in an interview that he gave over the phone last week. “The capital ratios are huge, the excesses on the asset side have been largely cleared out.”

Major lenders including Citigroup Inc. and Bank of America Corp. have sold off their assets, bolstered their balance sheets and cut many jobs after they repaid the 2008 taxpayer bailouts, when these companies were truly overwhelmed by losses on housing market related securities. All of those actions helped raise the value of Berkshire Hathaway’s holdings, and increase financial stocks at the same time.

Berkshire Hathaway has invested in at least four of the seven biggest lenders in the United States of America by assets, and has also taken out more than a $14 billion stake in Wells Fargo and Co., based out of San Francisco. They have a $5 billion stake in Bank of America, and they have $5 billion worth of warrants to purchase shares of Goldman Sachs Group Inc. Berkshire Hathaway has a stake in U.S. Bancorp as well.

“Our banking system is in the best shape in recent memory,” said Buffett.

Past bank regulators and executives tell us that the biggest lenders still pose some risk to the United States economy even four years after the bailout, plus 2 1/2 years since legislators passed the largest major reforms to regulation on Wall Street since the Great Depression.

Trading Loss

Last year, J.P. Morgan Chase and Co. took a trading loss of $6.2 billion, which reminded America of our concerns for the banking industry. Sandy Weill, former CEO of Citigroup, mentions that lending money and taking deposits should be split off from investment banking as a way to prevent another major financial crisis.

Other investors have also spoke about their doubts and the accounting of banks. Even after the stock rally last year, J.P. Morgan, Bank of America, Goldman Sachs and Citigroup are all trading at less their book value, which is a calculation of how much a company’s assets should be worth if you subtract their liabilities.

There were mergers taking place during the financial crisis that brought about criticism, saying that too big to fail banking companies are getting even larger. Buffett mentions that this shouldn’t worry investors at all. Canadian banks managed to get through this crisis a lot better than other banks in many nations, as the biggest firms in Canada took hold of more market share than their counterparts in the United States did.

U.S. Advantages

“We do not have an unusually concentrated banking system compared to the rest of the world, and there are certain advantages in the largest capital market in the world to have banks that are somewhat consistent with the size of those markets,” said Buffett.

The biggest United States banks are going to face another round of Federal Reserve stress tests to figure out whether or not they have enough capital to raise dividends and buy back shares of their stock. Brian T. Moynihan, CEO of Bank of America, tells us that he’s confident BOA is going to pass even though they failed in 2011, when he did not receive the approval to increase the dividend.

Buffett also lent Bank of America credibility by providing the bank capital during 2011, after the company saw a 45% decline in share price during an eighth month period. This trade also followed moves during 2008 that Warren Buffett made by helping out General Electric Company and Goldman Sachs during the financial crisis. Both of the companies bought back the preferred shares that they sold to Warren Buffett. He also expects that Bank of America may potentially do the same.

Improved Condition

“Their condition has improved so significantly, and interest rates are so low, that they have the chance to do a number of things in that respect,” said Buffett. “I may like to keep it, but if it makes sense for them to call it, they’re going to call it.”

The preferred shares that Berkshire Hathaway owns of Bank of America pay an annual dividend of 6%, and they can redeem them at any time for the amount of $5.25 billion, according to the terms of the deal that was made. The deal also gives Warren Buffett 10 year warrants to buy 700 million shares of common stock from Bank of America at $7.14 apiece. Bank of America recently closed at $11.43 per share. If Warren Buffett were to exercise that option at those prices, he would make about $3 billion.

Buffett mentions that Berkshire Hathaway is most likely going to wait toward the end of the contract before they exercise that option.

“We’re in no hurry,” said Buffett. “Nine years from now I would think that Bank of America as well as Wells Fargo and probably the other major banks will be worth considerably more than they are now.”

A spokesman for Bank of America named Larry DiRita chose not to comment on Warren Buffett’s Bank of America investment.

Their Tier 1 capital ratio has almost reached 9% as of September 30 based on the newest standards internationally, and it’s up from about 8% just three months earlier. Their long-term debt dropped to $286.5 billion by the end of the third quarter, and this is down from $399 billion just one year earlier.

When most people think of Warren Buffett and bank stocks, they usually think about the ever-expanding Wells Fargo and Company. But if you happen to take a look at the last 13 – F, you’ll see that Warren Buffett decided to triple his overall position in another bank stock. This actually suggests to me that there’s more than one mega-bank worth looking at right now. This particular bank is a low credit risk, and also has a lot of cash on hand, and there is a lot of room for it to expand internationally. So get those checkbooks out right now, bank stock buyers.

Difficult sector

It is not easy to invest in banks at the moment. I know you don’t want to hear this, but it really is the truth. It’s not like investing in a manufacturing company where you can predict what will happen during the next 10 years because it’s an easy to figure out revenue model. Banks are large, multifaceted and convoluted organizations. You should really only have them in your portfolio if you truly understand the ins and outs of the banking business. Otherwise, if you own them, you should have it on incredible authority that they are poised to make a consistent profit. That’s why a lot of people tend to often look to Warren Buffett and his investments as a good authority.

Not long after the financial crisis began, Berkshire Hathaway and Warren Buffett took out a few positions in some of the largest banks. One position they took out was in Bank of America, but this was more of a necessity to help out the ailing bank.

Warren Buffett also raised his position in Wells Fargo at this time, and is currently considered the best bank around right now. Wells Fargo is known to be a lot more conservative than its fellow competitors, such as J.P. Morgan Chase and Citigroup, and it has quite a bit of home mortgages currently on its books, which is excellent for the rebound in the housing market that is about to take place.

As a matter of fact, it looks like the housing market rebound has already begun at this point in time. It’s no secret that Warren Buffett’s Wells Fargo investment has already paid off big time for Berkshire Hathaway and the Oracle of Omaha. But there’s still one more bank that has quite a bit of room to go up in value in the foreseeable future, and Buffett is ready and waiting for his company to benefit when it does. Will you be waiting with him?

What a melon

As we review the latest 13 – F from Berkshire Hathaway, you will notice that Warren Buffett basically tripled his position in Bank of New York Mellon at this time. Bank of New York Mellon perfectly fits the investing style of Warren Buffett since it is a very conservative company, it has tendencies for cash printing, and the management in this business is very sound. There are a lot of appealing factors if you happen to be somebody looking for a cheap bank stock to purchase, and you are looking for exposure in the banking industry while keeping a very conservative approach.

The good thing for you conservative investors out there is that BNY is not one of these banks that make its money from banking practices that are morally wrong, as well as fly-by-night trades. About 75% of the revenue of this company comes from servicing fees that are recurring, and this is an excellent model which is obviously a perfect revenue model for a bank, or any company for that matter. BNY is actually the custodian of more than $27 trillion on a global level, and they are directly managing $1 trillion at the current time. I obviously do not need to point out that the servicing fees on $27 trillion are clearly going to be a really large chunk of change that is a fantastic recurring fee for Bank of New York Mellon.

The good old US of A

Another excellent thing that you might want to know about Bank of New York Mellon is that over 60% of their business takes place in the United States of America. But the company has a global presence that is expanding, and it is currently looking to earn more future revenue from other sections of the world as it expands. This is a really good opportunity for BNY because it has the ability to grow its business very fast since there are many different untapped markets all around the world just waiting for them. This is one of those rare cases of a stock that looks good for value investors, but the growth potential is also very strong as well.

Let’s stay on the topic of value for one second longer, because BNY trades pretty much like all of the other bank stocks are trading these days. As an investor in BNY, you only have to pay 0.78 times book value, which in my estimation is practically a fire sale. This is much less than 10 times its forward earnings, so it is only a little bit higher than Citigroup and J.P. Morgan as we speak, but the risk in this stock is considerably less than both of those mega-banks.

Since interest rates are increasingly low and basically staying there for the unforeseeable future, it obviously makes a great deal of sense to look into stocks that aren’t relying on the low interest rate to make its money. You want to look at banks that are focused on servicing the investments of its customer, which is exactly what BNY does. And they have drastically reduced their credit risk and interest rate, so they are able to offer their investors a really great business model of long-term revenue which is tough to pull off in the banking industry.

I want to remind you that it is not always really easy to invest in banks. You have to do a great deal of due diligence when evaluating a financial institution like this, and the only exception is with the local savings and loans. If you follow Warren Buffett’s lead by purchasing the stock because you feel it is an excellent choice, then you’d be in good hands since Bank of New York Mellon is very transparent with their current revenue streams, and they are also a exceedingly conservative business by nature. It obviously makes sense to follow the best in the world, and that is the exact opportunity that you have if you decide to follow Warren Buffett down this path.

There are a few similarities between the stocks that Jim Cramer likes and the companies that Warren Buffett currently owns. If you don’t know who Jim Cramer is, he is a host at CNBC and he has his own show revolved around the stock market called Mad Money. Although Jim is not technically allowed to trade for himself due to his contractual obligation, he does have a charitable trust which he regularly purchases stocks for as a way to benefit charity.

After reviewing Warren Buffett’s portfolio, and Jim Cramer’s charitable trust, we noticed that there are some stocks that they both happen to own. Let’s take a look at those stocks now so you can get a good idea where these two market giants meet in thinking.

The first stock that I want to mention is Wells Fargo and Company, which Warren Buffett has been a fan of for quite some time now. Berkshire Hathaway actually owns 400 million shares of this company since the end of June. This is about a 4% increase in the stocks that Berkshire Hathaway has of Wells Fargo since they owned it, and now it is also their second largest position only under Coke.

It also appears that Jim Cramer believes in Wells Fargo as well. His trust owns shares in this bank, and even though they have a relatively high valuation right now, they have a stable balance sheet and a proprietary brand that makes them an interesting purchase. Since they only have a trailing multiple earnings of 11, as well as their 2.6 dividend yield, we think that this is an excellent stock to buy and this is especially true when you compare it to similar banking conglomerates like Citigroup and J.P. Morgan Chase. Just to make it known, Cramer’s charitable trust also owns 2700 shares of J.P. Morgan Chase Bank and this position is actually larger than is Wells Fargo position.

Kraft Foods is also another stock that both Jim Cramer and Berkshire Hathaway own together. Just to let you know though, Berkshire Hathaway actually pared back their stake in Kraft, although they still own a total of 59 million shares. Jim Cramer’s trust also owns shares of this stock, but it is only a total of 2700. It is believed that Kraft is a good defensive position in the consumer goods sector, because you want to keep a diversified portfolio and this is definitely a good place to be. They have a 2.8% dividend yield, even though the stock appears to be price kind of high with a trailing price-to-earnings ratio of 21. The revenue and margins actually declined this recent quarter when compared to the same quarter last year.

The final common stock that Jim Cramer and Warren Buffett both own is CVS Caremark Corporation. Although Berkshire did cut their position in the stock during the second quarter, and they still own a total of 5.3 million shares. Jim Cramer’s trust owns 2300 shares of this company, and at this time it trades at 16 times trailing earnings, and will benefit greatly from the growth in its industry since there is a much greater demand for pharmacy services as baby boomers continue to get older.

If you want to actually copy some of the moves that Jim Cramer and Warren Buffett are making, then I recommend you choose Wells Fargo over the other choices. Although CVS is definitely a good buy, it makes more sense that Wells Fargo is actually the better choice.

Warren Buffett’s railroad Burlington Northern Santa Fe, which was recently bought by Berkshire Hathaway in year 2010, just sold $1.25 billion worth of bonds for the purposes of general corporate needs.

The bonds that Burlington Northern issued were split up into different parts. The first set of bonds, which went for the amount of $600 million, were at 3.05%, and they were 10 year securities which yielded 125 basis points more than other ponds that are similar. The second type of bonds were for $650 million and they were 4.375%, 30 year bonds and the basis points were 150 more than current benchmarks. This was gathered according to data presented by Bloomberg. Moody’s Investors Service is going to rate these bonds as A3, which is the fourth lowest investment grade that they have. Standard & Poor’s is going to be rating these bonds BBB+ which is even one level lower than the Moody’s rating. This is also according to information that was gathered by Bloomberg.

Burlington Northern has not sold any bonds since February. At the current time, the $625 million bonds they have at 4.4% that are due in 2042 in the month of March, are trading at 101.3 cents on the dollar, and a yield 4.32% as of yesterday. This information is presented by the company name Trace, which is a reporting system for bond prices of the Financial Industry Regulatory Authority.

Goldman Sachs Group Inc., Citigroup Inc. and Bank of America Corp. are the companies that managed the sale for Burlington Northern Santa Fe, which is a company based out of Fort Worth, Texas. The basis point is 0.01 percentage point.

The bank stock investors definitely have some choices that they are going to need to make since the largest banks in the nation have just reported their quarterly earnings.

Do these investors want to take a risk and chase the earnings rebound that is bound to happen at the major banks like Citigroup, Bank of America, and J.P. Morgan Chase Bank? There’s the potential for their shares rising well above single digit price-to-earnings multiples. Or better yet, would it be a better idea to invest in the safer premium priced lenders like U.S. Bancorp, BB&T, M&T Bank and Wells Fargo?

The one thing I can say for sure is that if you followed Warren Buffett’s lead, and invested in the traditional lenders such as Wells Fargo, then you would have implemented a very effective yet simple strategy. This industry is normally marked by high risk and earnings numbers that are very hard to understand.

To put it quite simply, Warren Buffett who is also known as the Oracle of Omaha, made the choice to invest his money in banks that were growing earnings through mortgage lending rebounding a bit, as well as low-cost share repurchases that are now going up in value.

On the flip side, Warren Buffett has hesitated when it comes to putting more money behind the players more oriented toward the capital markets such as J.P. Morgan, and he’s even backed off of the Wall Street investment banks such as Morgan Stanley and Goldman Sachs since they are at risk from the malaise on Wall Street, as well as the European debt crisis and new regulations that are coming into play each and every day.

Buffett has been sticking with the mid-teen price multiples of U.S. Bancorp, M&T bank, and Wells Fargo, as opposed to going after the single digit P/E ratios of some of the previous banks mentioned in the paragraph above.

Buffett chose to avoid making common stock bets in investing banks, which is why the investments Buffett made in the financial sector are outperforming those of his peers by a wide margin. The second quarter earnings of the bank stocks that he owns definitely reaffirmed that his way of investing is certainly the smart way to go. Wells Fargo and J.P. Morgan Chase Bank both started off this earnings season with much stronger than expected numbers, and Wells Fargo even outperformed expectations, which I learned according to data released by Bloomberg.

When you take a close look at Buffett’s portfolio of bank stocks, the outperformance is a marked improvement which you will certainly notice.

The top performers in the banking sector of the Standard & Poor’s 500 index, since earning season began are both M&T Bank and U.S. Bancorp. And the laggards in the banking sector are Bank of America, Goldman Sachs and Morgan Stanley.

That doesn’t mean that Buffett doesn’t have any investments in either Goldman Sachs or Bank of America. But he made preferred share investments which are extremely safe loans that will guarantee him a return on his investment. This has nothing to do with the regular trading of the common stock, and it’s a totally different type of investment opportunity which is paying off for Berkshire Hathaway.

It’s probably not a great idea to base your investment strategy off of the bank stock gains that have been taking place since the second week of July. But I’d like to point out that the performance of shares is actually reinforcing trends over the last few years which you also see reflected in earnings statements.

Buffett and company are continuing to hold their bank stocks because they believe in the investment in the US economy and recovery, but he did it wisely by smartly placing his money in banks like Wells Fargo (they are projected to be the most profitable bank in 2012 according to computations and analyst estimates from Bloomberg.) There are many other investors who are being lured into subpar investments by placing their money into the large financial banks that have troubled balance sheets and uneven earnings.

The Wall Street crash in 2008 hammered most of the bank stocks, but then in March 2009 the bottom of the stock market crash is where the bank shares began to triple in value for Bank of America and Citigroup, and Goldman Sachs and J.P. Morgan all doubled in value in a one-month period. There are lots of analysts and investors in the financial sector who believe that those mega gains could be duplicated once again in the very near future.

But the truth is that our nation’s biggest investment banks have totally underperformed, but that didn’t stop their shares from rising higher due to some deal making and misplaced optimism.

Between the months of March 2009 through May 2009, the nation’s biggest investment banks were actually the top performers at the time. But things have changed, and since that three-month period, Citigroup, Goldman Sachs, Morgan Stanley and Bank of America have all lost more than 15% of their share value. All of these stocks are part of 10 bank stocks on the S&P 500, out of a total of 85 bank stocks in all, that have taken double-digit losses since May 2009. This information was obtained through Bloomberg data.

J.P. Morgan on the other hand has gained about 20% since that time. But Bloomberg data also shows us that the financial stock picks that Buffett made in M&T, U.S. Bancorp and Wells Fargo have all gained much better returns, and outperformed Chase by a wide margin during that same time.

If anything, I hope this market data will show investors that these large banks with volatile earnings aren’t necessarily the smart play, no matter what the big financial media reports show you. If you were to follow the less glamorous bank stocks that Warren Buffett chose, then you would’ve been much better off and gained some great exposure to consumer and mortgage lender growth.

The strategy is definitely confirmed by the earnings reports that have recently come out in the financial sector. The truth is that the strength in the lending gains are the reason why these earnings have propelled at Wells Fargo, and the reason why they outperformed expectations. The same holds true for J.P. Morgan.

When the second quarter earnings were released, it was learned that Wells Fargo beat the street because of a 35% increase in their quarterly profits. This number was bolstered by housing related activity and mortgage lending. J.P. Morgan, on the other hand, showed major growth in the area of new and existing homes, and they had a 30% year-over-year growth in the mortgage loan origination revenue department. The growth was also 14% sequentially which rose to $43.9 billion. But they showed a sharp drop in profits in the investment bank area.

The fact that J.P. Morgan had a major boost in their home lending earnings was actually a major bright spot throughout the entire second quarter. This was an earnings season that showed a sharp drop in revenue from the investment banks, and the $4.4 billion “London Whale” trading loss. Traditional revenues in investment banking fell a great deal on Wall Street, and in Morgan Stanley’s case they dropped about 50%, and the large bank earnings were unfortunately clouded by a lot of accounting items that only represent a onetime situation. There’s also the possibility that the rate fixing scandal going on at Barclays is going to spread and that will negatively affect the large banking conglomerates.

“With roughly 80% of the banking industry by assets having reported 2Q12 results, the overarching theme of earnings has been continued impressive mortgage banking revenues, surprising [net interest margin] resilience, and modest loan growth,” said Paul Miller who is an FBR Capital Markets analyst in a July 23 earnings wrap. “Given a sustained low rate environment, government mortgage programs, and constrained market capacity, we believe that mortgage banking will continue to be a dominant earnings driver through the end of 2012,” he added.

Banks such as Wells Fargo, Fifth Third, PNC Financial, J.P. Morgan and U.S. Bancorp, who all have large mortgage banking platforms, will all continue to be supported by home buying activity and refinancing, mentioned Miller.

As a matter of fact, the recent earnings numbers actually reinforce some of the things that Warren Buffett forecasted about the housing market in an interview that he gave on CNBC on July 12. He mentions that our economic growth in this country has basically stopped dead in its tracks, but he’s noticing that there is a pickup in the residential housing area, which was a comment that he made in regards to bank earnings.

“The general economy in the United States has been more or less flat, and so the growth has tempered down. But the residential housing, we’re seeing a pickup. It’s noticeable. It’s from a very low base,” Buffett said, who stated that he recognizes that he sort of flip-flopped with his optimism when he was very bullish on this topic of housing in 2011.

There are lots of housing sector analysts and banks that also agree with him. The analysts from Goldman Sachs actually raised their earnings estimates on two of the homebuilders which included MDC Holdings and KB Home, because the analyst believes in a “strong US housing recovery.”

If you are a stock investor that trusts in the fundamentals, you should also consider following Buffett. According to the results of the stress test of the Federal Reserve in March, Buffett led the way with his investments in such areas as U.S. Bancorp and Wells Fargo, and this also pushed forward some share buyback plans and dividend boosts. The Wells Fargo dividend was raised by 83%, and this was followed by an accelerated buyback program which began in the year 2011. U.S. Bancorp, on the other hand, also boosted their dividend by a total of 56%, and they even plan to buy back $3.3 billion worth of shares.

There aren’t many Americans who are aware of this fact, but the truth is that Berkshire Hathaway has been steadily and quietly putting themselves in a position where they will play an important role in the mortgage market that Bank of America, and others, are currently shying away from at this time.

Did you know that Berkshire Hathaway is actually in a bidding war with Nationstar Mortgage Holdings? They are bidding to receive the assets of ResCap, which is actually the fifth-largest mortgage servicer in the nation, behind such major financial institutions as Citigroup, J.P. Morgan Chase Bank, Bank of America and Wells Fargo.

Whoever wins this bid is going to instantly become a large player in the mortgage servicing industry, and they will have the ability to collect the debts of 2.4 million home loans once this deal is complete. The significance of the move they’re trying to make is that many of the other larger banks, with the one exception being Wells Fargo, is that they are all choosing to pull out of this facet of the financial services industry. In particular, Bank of America has been regularly selling off the rights to their mortgage servicing business.

This week is very important for the United States housing market, and we are looking for a quiet shift in this industry as new details come about. How is this going to happen? Ocwen Financial Corp., which happens to be the 13th largest mortgage servicer, and Fortress Investment Group, the company that owns a Nationstar, are going to be reporting the results of their second quarter earnings this Thursday in the morning.

You can definitely expect that Fortress is going to be asked plenty of questions about Warren Buffett’s battle for ResCap, and I wouldn’t be surprised if Ocwen management also gets questions about the specific topic, since they have expressed their own interest in purchasing the assets of ResCap.

Another potential area you might want to find out more details is with Bank of America selling off their mortgage servicing rights. They have sold the rights to over 15,000 loans so far, even though the United States Justice Department is currently reviewing them which is holding up the sales. This is according to the CFO of Bank of America, Bruce Thompson, on July 18 when his company reported their earnings.

When asked about the delay in loan sales, Thomas predicted that it would last between one to two quarters. What would really be interesting is finding out what Fortress and Ocwen have to say in regards to purchasing MSRs from Bank of America.

I recently had the opportunity to take a look at Berkshire Hathaway’s 2011 annual report. In that report it showed that Buffett and company invested in 11 companies by purchasing their common stock during the same year. Every single one of these companies had a market value where their company exceeded $1 billion. But out of all 11 companies, there has only been one where he’s been adding to his position since the year 2005. The name of that company is Wells Fargo (WFC).

In all actuality, Wells Fargo is actually the second largest investment that Berkshire Hathaway currently holds. The total value of their investment is $13.7 billion. IBM is their third largest investment, and it values at $12.6 billion. While Coca-Cola is the largest investment of the company worth a total of $15.6 billion.

What you may not know is that Berkshire Hathaway actually took out their initial position in Wells Fargo in 1990. They spent a total of $289 million to purchase 5 million shares of the company. The position stayed stable from 1990 all away through 2004. Wells Fargo merged with Norwest in the year 1998, and the Wells Fargo stock was converted so one share actually ended up becoming 10 shares in the conversion. Ever since 2005, Warren Buffett and Berkshire Hathaway have added to their Wells Fargo position on a relatively regular basis.

This is how it has all broken out:

• In 2005, they purchased 38.7 million shares at an average price of $30.58 per share. The total cost for this purchase was $1,183,000,000.
• In 2006, Berkshire Hathaway purchased 28 million shares at an average price of $33.65 per share. The total cost of this purchase was $942 million.
• In 2007, they purchased 85.2 million shares at an average cost of $33.64 per share. The total cost of this purchase was $2,886,000,000.
• In 2008, Warren Buffett bought 1 million shares of Wells Fargo at an average cost of $32.29 per share. So the total cost was a little more than $32 million.
• In 2009, Berkshire Hathaway was able to acquire 29.8 million shares at an average price of $19.67 per share. The total cost of this purchase was $586 million.
• In 2010, they chose to buy 24.7 million shares at an average price of $28.64 per share. This totaled $707 million.
• The 2011 share purchase was for 41.1 million shares at an average price of $28.42 per share. The total cost of this purchase was $1,168,000,000.
• Finally, in the first quarter of 2012, Warren Buffett purchased 10.6 million shares of Wells Fargo at an average cost of $30.85 per share. The total cost of this purchase was $327 million.

All of this information was gathered from Berkshire Hathaway’s annual reports. Feel free to read through the annual reports on your own if you want to verify this information.

During the most recent annual meeting for Berkshire Hathaway, Wells Fargo was praised by Warren Buffett and he came right out and told us that it is one of his favorite investments. They’re actually ranked among the US banking industry as number one in total market value being worth $176 billion.

This is true even though it is only the fourth largest bank when you add up its total assets. They actually have the most extensive network of branch banks throughout the entire United States of America, and they total 6200 retail branches throughout 39 states of the USA. They also serve one out of three homes in the USA, and they are the originator of one out of four home mortgages and they even service home loans more than any other bank in the industry.

One thing you might want to note is that Wells Fargo has stuck with its plan by narrowing its focus. It planned on developing its original mission of commercial banking, and it has succeeded wholeheartedly in this endeavor. They never changed course along the way by jumping into high risk investment banking. This was the downfall of a lot of their major competitors. They also stayed local, whereas many of the competitors expanded into Europe. This is a major problem for some of these banks since many countries in Europe are experiencing enormous challenges from a financial perspective.

Wells Fargo’s assets are basically all in the US. A total of 97% of their assets are United States based, and 98% of their employees are also in the USA. They have a cross-selling strategy which they vigorously pursue, and they make it a point to get their existing customers to use additional products. This is a substantial part of their success, as the average customer of Wells Fargo actually uses around six products that their bank has to offer. This is much different from the way they operated where they only offered one or two in the 1980s.

Wells Fargo pulled in a net income of $16 billion in 2011. This is up from their numbers in 2008 where they only made 2.7 billion. They also made a major purchase in 2008, and they purchased Wachovia Bank for $15 billion during that year. This was a big addition to the bank because it expanded their presence in the South as well as the East in the United States. They were also capable of entering into brokerage services through this purchase since Wachovia is also the owner of A.G. Edwards. This gave them a much greater ability to cross sell more products to their existing customers.

The most important thing about Wells Fargo is their loan portfolio. It is in much better shape than the portfolios of their competition. Their net charge-offs were only 1.25% of their total loans of the first quarter of 2012. Bank of America’s net charge-offs were 1.8% and J.P. Morgan Chase’s net charge-offs were 2.19%. Citigroup was the worst at 3.19%.

There are many analysts expecting Wells Fargo to earn more than 10% per share over the next five years. The shares are currently valued at a reasonable 10 times earnings. This makes Wells Fargo a very attractive investment when you base it on risk/reward.