Smead Capital Management Asks - Will Buffett Be Right on Wells Fargo?
A mentor early in my career told me this adage about stocks, "in the short run, 70% of stock performance is market related, 20% is industry related and 10% is company related." He went on to say, "over ten years, stock performance is 70% company specific, 20% industry specific and 10% is market related.” We believe we are among the other 100% of market participants who are incapable of adding value via market timing. Based on this ideology, we analyze companies based on ten-year time frames where 90% of the results are dictated by stock and industry selection. We can't know or care to know what the stock market will do in the next year.
Peter Lynch back in the 1980’s championed the idea of performing long-term research on stocks to find what he called ten-baggers. Ten baggers to him were shares of stock which could appreciate more than ten times your entry price over longer term time frames. He was looking for a company with economic dynamics that could lead to explosive long-term earnings growth, possessed an attribute which would prevent extreme popularity and had company characteristics which indicated long-range quality in the business (balance sheet, free-cash flow, etc.). His two favorites were Phillip Morris and Fannie Mae. He liked the economics of Phillip Morris and knew that regardless of how well the business did; a large group of investors would dislike the company intensely. In other words, it would never get popular. Fannie Mae was the same way back then, it had a great business and most investors never understood them in the 1980's and 1990's.
If you buy a stock and hold, it for 15 years and it goes up ten times what you paid for it, it is highly unlikely any investor would be upset that they didn't buy at the bottom. There is an old saying in the investment business, "Only liars buy at the bottom." If a stock goes from $30 per share to $300 per share in twenty years, we believe it doesn't make much difference to you if you paid $30 or $36 or $42 along the way. A good picture of the how this plays out in real time is found in an article from the Motley Fool about Warren Buffett:
“Recalling the days in early March when Wells Fargo (NYSE: WFC) slipped below $9 a share, Buffett -- without the slightest hesitation -- stated, ‘If I had to put all of my net worth into stock, that would be the stock.’"
Considering that his favorite holding period is "forever", what can we say about his long-term view of the stock market potential of Wells Fargo (WFC) back then? Also, what do the constant additional purchases by Berkshire Hathaway every quarter since then at higher and higher prices say about the long-term potential for the stock price?
We believe the answer is that Buffett is a subscriber to my friend's theory: “it doesn’t make any difference what price you pay.” First, because Buffett earned a return of over 25% compounded from 1969 to 1999 on his stock portfolio, we could hypothesize that the long-term potential of Wells Fargo at $9 per share was as good as any of his best possibilities during that time period. If Wells Fargo compounded at 25% over the twenty years ending March of 2029, each $9 dollars invested would grow to $832 of value from a combination of appreciation and common stock dividends. We have even left ourselves a margin of safety, because Buffett wouldn’t have said that in 2009 if he didn’t believe that Wells Fargo at $9 per share ranks among his best ideas over the decades.
For this reason, paying $44.65 (intraday July 19th, 2013) per share looks very attractive, if you find truth in our thesis on Buffett's original statement. A purchase here with nearly 16 years left until 2029 looks very appealing to us if the ultimate result comes anywhere near our hypothetical analysis of $832 per share of wealth created on the $9 original investment. Our view of this is that the move from $9 per share to $44.65 is a splendid start on our thesis and leaves a wonderful amount of wealth creation for those of us who “tell the truth” because we didn’t buy all of our shares at the bottom. In the aftermath of the financial meltdown, stress-test related capital restrictions appear to be causing most of the dividends and dividend growth in the Wells Fargo story to be back-end loaded.
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