We agree with Warren Buffett, banks are great investments. So why are people so pessimistic?
Warren Buffett, who is probably the most successful long-term investor, says banks are great because they are “very good investments at sensible prices… and they are cheaper than other businesses that are also good businesses, by some margin.” He’s put his money where his mouth is; bank stocks represent a $100 billion-dollar investment or 20% of Berkshire Hathaway Inc.’s value. Seven of the top ten holdings in his portfolio are bank stocks.
He has chosen the same stocks we own; JP Morgan Chase & Co., Wells Fargo & Co., PNC Financial Services Group, and The Goldman Sachs Group, Inc. He, like us, sees the value these companies gained by the major tax overhaul of last year. He likes the strong balance sheet, rapidly rising dividends, and the significant margin of safety these companies have because of their low relative valuations to most other stocks.
Some investors are selling almost every type of investment because of the fear of an economic slowdown. A slowdown could hurt bank profits, yet there is no sign of stress. Consumers are employed, home prices are firm, and debt levels (in America) are low. Bank exposure to trouble loans are very low and show no signs of rising. Interest rates are incredibly low (and falling) and while that is good for borrowers, some worry that it makes it tough for banks to make loans at attractive profits. While low rates are pressuring banks to remain cost-conscious and vigilant, banks just reported record profits and increased dividends. Low rates haven’t stopped banks from making money. They are banks! They just charge you more fees.
Presently, investors will lend money to Wells Fargo for 10 years at 2.8%, but if you own the bank you earn 4.6% over the same amount of time. Which would you prefer, 2.8% or 4.6%?
People think Warren Buffett is one of the smartest investors of all time. His strategy is clearly laid out in the logic that 4.6% is better than 2.8%. Could Wells Fargo fall in price? Sure, but so can that 2.8% bond and with a 10-year view. Being an owner of a bank where you can borrow money at 2.8% and pay yourself 4.6% looks pretty smart to us, too.