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For Berkshire Hathaway's Warren Buffett, Wells Fargo Inc. Investment Is Getting Personal

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Feb 19, 2009
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Warren Buffett is one of the world’s wealthiest people. Despite his high public profile, decent people would respect his privacy and will not want to peek into his personal life, not until he invited us to. Aside from his shares in Berkshire Hathaway Inc., we consider how he manages money in his personal accounts a private matter, in despite of our strong curiosity. That has been changed since October, 2008.

In his well-known Op-Ed NY Times article, “Buy America. I am”, Warren Buffett meant to say he was buying US stocks in his individual personal account:

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

I take that as a open invitation. He stated in the past he had only held government bonds and shares of Berkshire Hathaway (BRK-A). So what exactly did he buy since October of 2008, for himself?

Of course, he wouldn’t tell, that does not stop the rest of us from guessing and searching. According to this SEC Schedule 13-G filing, Warren Buffett bought 2,240,000 shares of Well Fargo & Co. (WFC, Financial) in the fourth quarter of 2008, probably around the time when he published the Op-Ed article. In the same 13-G, Warren Buffett stated he now controls 314.6 million shares or 7.4% of the bank holding company, through his nebulous subsidiaries (290.2 reported in Form 13F for Berkshire Hathaway Inc., 22.1 million reported in Form 13F for General Re New England Asset Management, Inc., and 2.2 million share for Warren Buffett himself. ). Even at today's depressed price, the Wells Fargo holding is nearly 10% of Warren Buffett's total stock holding.

Why Does Warren Buffett Likes Well Fargo So Much?

Warren Buffett started to buy Well Fargo in late 1980s. In his Chairman’s Letter to Berkshire Hathaway Shareholders of 1990, he made his case:

Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings. The exception was Wells Fargo, a superbly-managed, high-return banking operation in which we increased our ownership to just under 10%, the most we can own without the approval of the Federal Reserve Board. About one-sixth of our position was bought in 1989, the rest in 1990.

The banking business is no favorite of ours. When assets are twenty times equity - a common ratio in this industry - mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.

Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices.

With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen. In many ways the combination of Carl and Paul reminds me of another - Tom Murphy and Dan Burke at Capital Cities/ABC. First, each pair is stronger than the sum of its parts because each partner understands, trusts and admires the other. Second, both managerial teams pay able people well, but abhor having a bigger head count than is needed. Third, both attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, both stick with what they understand and let their abilities, not their egos, determine what they attempt. (Thomas J. Watson Sr. of IBM followed the same rule: "I'm no genius," he said. "I'm smart in spots - but I stay around those spots.")

Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.

In other words, back in 1990, he liked Wells Fargo because he liked the management and he liked the price (about 50% discount), despite he had his reservation in the banking business in general.

Risks of Investing In A Bank

Clearly, Warren Buffett was fully aware of the perils of investing in the banking businesses. The 1990 letter went on stating:

Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

A year like that - which we consider only a low-level possibility, not a likelihood - would not distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity. Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices.

Does that sound familiar? This time around, Warren Buffett put his personal money on the line and bought over 2.2 million shares. The investment so far has not been very successful. Since the beginning of 2009, the stock has fallen from $30 per share to less than $13, a drop of nearly 60%.

Based on what we know about Warren Buffett, we do not think the stock price drop will deter him from buying more of the company unless he has second thoughts on the long term intrinsic value. In any event, GuruFocus will continue to monitor and situation and report to you.
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