1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Rupert Hargreaves
Rupert Hargreaves
Articles (1317)  | Author's Website |

Why Does Warren Buffett Like Bank of America?

A look at Berkshire's largest bank holding

At the end of the second quarter of 2020, Bank of America Corp (NYSE:BAC) was the second-largest position in Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) extensive equity portfolio. Warren Buffett (Trades, Portfolio)'s conglomerate owned 925 million shares in the banking group. The position accounted for 11.2% of the portfolio, making it the second-largest holding after Apple's (NASDAQ:AAPL) 36%.

Buffett has also increased the Bank of America position by $2.1 billion, or 10%, since the end of the second quarter.

So what does Buffett like about Bank of America in particular? The banking sector as a whole is facing some severe headwinds right now. The coronavirus pandemic has led to America's biggest banks suffering steep declines in net interest margin, traditional banking revenues and total revenues.

These financial institutions have also had to write off tens of billions of dollars in bad debt already. For example, Bank of America's second-half results fell around 50% year-over-year. The group reported $5 billion in loan loss charges linked to the pandemic. It's unlikely the situation is going to improve any time soon. More loan losses seem likely before the end of the year given the economic recession.

That said, we know Buffett never buys an investment based on its prospects for the next 12, 24 or even 36 months. He buys stocks when he plans to hold them forever. It is unlikely to be any different with Bank of America.

Buffett has previously called banks good businesses because they can earn very high returns on tangible capital. These are just a sort of companies Buffett has sought out throughout his entire career. Bank of America's return on tangible equity has ranged between 8% and 14% during the past five years.

Buffett may be attracted to the lender for its other desirable qualities as well. The bank is extremely well capitalized and has strong recognition among consumers across the country.

Bank of America's required CET1 ratio is 9.5%, but its current CET1 ratio at the end of the second quarter is 11.6%. These numbers suggest that unless there's a significant deterioration in loan losses, the bank can potentially return a substantial amount of capital to investors in the years ahead. The bank already has an impressive track record on this front. At the beginning of the year, Bank of America was targeting $37 billion of capital returns in 2020. That was equivalent to a shareholder yield of 12.2% at the time. In 2019, the ratio was around 14%.

Conclusion

All of the above indicates that Bank of America is a highly profitable company and is committed to returning capital to shareholders. Few other businesses offer the same kind of profitability and return profile.

Right now, investors can buy a share of this business for less than book value and less than 10 times earnings. From a value perspective, the stock is cheap, and from a quality perspective, it is also a desirable investment, in my opinion. These qualities make it clear why the Oracle of Omaha is interested in buying the business.

Disclosure: The author owns shares in Berkshire Hathaway.

Read more here:

Not a Premium Member of GuruFocus? Sign up for afree 7-day trial here.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


Rating: 5.0/5 (5 votes)

Voters:

Comments

raj123456789
Raj123456789 - 2 months ago    Report SPAM

why BAC and not WFC?

sf_tsai
Sf_tsai - 2 months ago    Report SPAM

Great analysis!

kennys
Kennys - 2 months ago    Report SPAM

Hi Rupert, I have a few questions - "Bank of America's return on tangible equity has ranged between 8% and 14% during the past five years" <- Is this high? why do you look at return on tangible equity, and not traditional marker such as ROIC-WACC? Also, why is return on Tangible equity more accurate than ROE, considering that banks are adopting an online business model more and more? ROE for BAC is about 7% lately, which seems low. I may be completely wrong. Thanks!

Rupert Hargreaves
Rupert Hargreaves - 2 months ago    Report SPAM

Hi Kenny,

To answer your first question, yes 8% to 14% is high. As Buffett explained in a later interview, a 14% return compared to the risk free rate (<1%) is highly attractive.

On your second point, it's mainly to do with bank accounting. I'm not qualified to give a detailed explanation, but put simply ROE can be easily distorted on highly leveraged balance sheets. Banks rely on leverage. What's more, Buffett has always stayed away from WACC -- I think he's said before he doesn't trust the calcautions required to compute it.

Hope that helps.

Rupert

kennys
Kennys - 1 month ago    Report SPAM

Oh great. Thanks for educating. Learned something new today.

Please leave your comment:



Performances of the stocks mentioned by Rupert Hargreaves


User Generated Screeners


pjmason14Momentum
pascal.van.garsseHigh FCF-M2
kosalmmuse6
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
kosalmmuseNice
kosalmmusehan
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)