Why Buffett Still Holds Bank of America

Here’s a quick Bank of America summary…

  • The mistake made by the company involving $4 billion of Merrill Lynch structured notes creates a major concern about the immediate term capital return plans for Bank of America.
  • Even though it’s hard to tell, the core business of Bank of America earns about $1 billion per month in net profit.
  • Warren Buffett is going to make Bank of America one of his bedrock holdings in the Berkshire Hathaway portfolio starting near September 2021. The bank has serious earnings power once all of the litigation woes subside.

“It is important for you to realize that Bank of America is, in effect, our fifth largest equity investment and one we value highly…We can buy 700 million shares of Bank of America at any time prior to September 2021…We are likely to purchase the shares just before expiration of our option,” said Warren Buffett in his 2013 letter to shareholders.

It seriously looks like Bank of America is being forced to call an audible. For shareholders that looked upon the $4 billion buyback and the annual dividend at $.20 last month as a signal that the first steps of the road to recovery are beginning, we also learned disappointingly that accounting errors were the reason why the bank overstated their capital by about $4 billion-$5 billion. Because of this, Bank of America had to resubmit their capital plan.

There are a few options that Bank of America may choose to pursue when creating the revised proposal to the Federal Reserve. First off, they can leave the quarterly dividend at a penny and stick with the $4 billion buyback. For value investors, this move would likely be very appealing. Buybacks are typically beneficial when the price is at a heavy discount to intrinsic value. But there’s a catch… Prices are typically low during these periods when it’s often politically unfashionable to buy back stock.

In the end, Bank of America is much better capitalized today than they were before the financial crisis, even though it may not seem like it. 2013 is actually the fifth most profitable year in the history of the financial banking giant. It just doesn’t seem like it because since 2008 there are twice as many outstanding shares.

The company’s current earnings power is roughly around $1.50 per share, and that figure is looking to rise as problematic assets find their way off of the balance sheet. If you are ready to act for the long-term in 5 to 10 year increments, this might be another fantastic example where you can do very well for yourself by following the lead of Warren Buffett, even though Bank of America’s price is currently higher than the amount he paid in 2011.

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