There’s Real Value In Warren Buffett’s Bank Stock Picks

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.

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