Over the past decade, one of the most notable changes in Warren Buffett (Trades, Portfolio)'s portfolio is his increased allocation toward banks and financial stocks.
Indeed, over the last 10 years, Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) bank holdings have gone from virtually zero to making up five out of the conglomerate's top 10 equity positions.
Together, Bank of America (BAC, Financial) and Wells Fargo (WFC, Financial) make up 22% of Berkshire Hathaway's equity portfolio. The company owns just over $40 billion worth of stock in these two banks.
Buying stocks cheap
Buffett has always had a soft spot for financials, if he can pick them up at the right price. Back in the 1980s, he invested in Federal Home Loan Mortgage Corp. (FMCC, Financial), also known as Freddie Mac, picking up a business that was trading for less than eight times estimated earnings, delivering a 23% return on equity. In a 1988 interview with Fortune Magazine, he elaborated on why he decided to establish a position in this enterprise:
"You've got a low price-earnings ratio on a company with a terrific record...You've got growing earnings. And you have a stock that is bound to become much better known to equity investors."
By the early 2000s, however, Buffett had soured on Freddie Mac and its partner in crime, Fannie Mae. In 2000, Berkshire sold its Freddie Mac holdings. At the 2001 annual meeting, one shareholder wanted to know why he had decided to take this course of action. He replied:
"There were certain aspects of the business that we felt less comfortable with as they unfolded...
And the consequences of what we saw may not hurt the companies, I mean, at all. But they made us less comfortable than we were earlier, when, actually, those practices or activities didn’t exist...we felt the risk profile had changed somewhat."
I think this is a fascinating insight into the way Buffett was thinking at the time. He could see the financial services industry was changing, and didn't want to risk being exposed to any adverse developments that might emerge going forward.
Discomfort around financial institutions
Interestingly, at the 2001 meeting, both Buffett and Charlie Munger (Trades, Portfolio) then went on to say they were "uncomfortable around financial institutions."
"We feel there’s so much about a financial institution that you don’t know by looking at just figures, that if anything bothers us a little bit, we’re never sure whether it’s an iceberg situation or not," Buffett said.
Buffett went on to say, "We have seen enough of what happens with financial institutions that push one way or another, that if we get some feeling that that’s going on, we just figure we’ll never see it until it’s too late anyway."
"It’s different than buying into a company with a product or something, or a retail operation," he added. "You could spot troubles usually fairly early in those businesses. You spot troubles in financial institutions late. It’s just the nature of the beast."
Having this opinion undoubtedly helped Buffett and Munger avoid the worst of the financial crisis, but it is interesting to note they were both negative on the financial sector before 2008.
During the crisis, Berkshire Hathaway (and the Daily Journal (DJCO), where Munger is the chairman) started buying financial stocks. Berkshire Hathaway has been dramatically increasing its allocation toward the sector ever since.
Conclusion
I don't think it is wise to try and second-guess why the Oracle of Omaha is making a decision - he has his reasons. Still, in this case, I would say he has changed his opinion toward the sector due to improving regulation and the highly attractive prices he has been able to achieve over the past 10 years.
Whatever the reason for buying, it is interesting to note that at the turn of the century, he was quite happy to avoid the sector altogether.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
