Not to beat a dead horse, but this Wells Fargo situation kept lingering in my mind so I thought I’d make this followup post. It is well understood by value investors but since I have a pretty wide readership in terms of stock market experience, I thought I’d post this because there is something to be learned from thinking about WFC, Buffett and how the market works.
What Mr. Market Sees
- Mr. Market sees a volatile stock. WFC went from $40/share to below $10/share during the crisis; way too volatile. A 75% decline is just unacceptable to own for a conservative portfolio. Of course, Mr. Market is the cause of this volatility. The volatility just illustrates the manic-depressive nature of the stock market.
- Not only is the stock very volatile, but it has gone nowhere for a long time.
- Mr. Market views banks as too risky not only because of the stock price volatility and gone nowhere-ness, but because it’s too complex, opaque and leveraged. Mr. Market prefers the ‘safety’ of bonds, the ‘safety’ and non-correlatedness of private equity funds, hedge funds and other alternative investments as the stock market has done nothing in the past decade and is just way too risky.
- Mr. Market sees no future for the banking industry; higher capital requirements and heavier, more extensive regulation makes the future of the industry bleak. Also, the size of some of the bigger banks (like WFC) makes it unlikely it can grow more in the future. Skeptics point to the lame top line growth at many financials in recent years.
- Mr. Market reads newspaper and magazine articles that predict a repeat of the most recent crisis; people tend to spend a lot of time fighting the last war. There is a weird obsession in the media with large, ‘evil’ banks who have gotten away with murder unpunished.
What Mr. Buffett Sees
- Mr. Buffett does not care about stock price movements. He only cares about the health of the underlying business. He believes that stock prices will generally reflect the value of the business over time, but not every single day, month or even year. Stock prices can be misvalued for long periods of time. This does not bother Mr. Buffett in the least. If a stock goes down 80%, he doesn’t care as long as the intrinsic value of the business hasn’t gone down 80%. He worries about permanent loss of capital, but never worries about temporary loss of capital due to stock market volatility (if you want to avoid this temporary loss of capital, as in anything else, there will be a cost!).
- Mr. Buffett is in no rush to get rich (or richer, I should say). Much of the folly in financial markets comes from the need for people to get rich quickly. In fact, I’ve had people tell me that they speculate in foreign currencies at 100-1 leverage because they said they are not rich enough to be able to buy stocks and wait for them to go up over the long term like Mr. Buffett, nor are they smart enough to be able to pick stocks like Mr. Buffett. Another favorite is that they simply don’t have the time to be reading annual reports. Of course, it never occurs to them that if they are not smart enough to pick stocks, who says they are as smart as Soros to be able to make money trading FX? Needless to say, I’ve never heard of a good outcome from people who have said this to me.
- Going back to bullet point one, Mr. Buffett only cares about the underlying fundamentals of the business. While Mr. Market focuses on the stock price movements in the above chart, Mr. Buffett focuses on the following table which shows how WFC has grown BPS over time (including dividends):
WFC BPS growth (including dividends)
- The above table is just astonishing. Show this to someone without telling them what it is. Ask them, would they invest in a fund like this? If this wasn’t a major bank, people would be all over this thing. How many funds or hedge funds have this kind of track record? This is what Mr. Buffett looks at; not stock price history (except when buying shares, price is important so as not to overpay).
- Having looked at this, it solves another puzzle. For years, Berkshire Hathaway (BRK) fans have been calling for share repurchases and dividends and things like that. People seem to be very upset that Mr. Buffett hasn’t bought back more shares. Now we can see why he hasn’t been buying back more shares; he sees something better. Here is the above table with BRK’s own BPS growth right next to it (be sure to be seated when viewing this table, or hold onto something):
2002 +19.1% +10.0%
2003 +21.4% +21.0%
2004 +19.2% +10.5%
2005 +17.5% +6.4%
2006 +21.0% +18.4%
2007 +15.1% +11.0%
2008 +20.8% -9.6%
2009 +27.1% +19.8%
2010 +13.2% +13.0%
2011 +11.7% +4.6%
2012 +15.8% ?
5 year avg: +17.6% +7.3%
10 year avg: +18.2% +10.2%
OK, so I cheated as we don’t have BRK’s 2012 BPS yet. BRK five and ten year periods are through 2011. But I don’t think it makes a difference in the story it tells. WFC’s performance is just amazing compared to BRK. It has beaten BRK in every single year, and in most years by a pretty wide margin. This is unbelievable. And this is the decade that included the financial crisis?! You’da thunk BRK woulda done better than a major bank with tons of mortgages.
Go through the table again, starting at the top and slowly look at both figures, year by year, and imagine the headlines in those years. You would never have guessed the outcome of these two entities in any of these years.
There is a tremendous bias against banks these days, but if there wasn’t, Mr. Buffett’s thinking should be as clear as anything. You would be insane to call for him to be buying back BRK stock when he can be buying WFC at an attractice price.
In fact, if Mr. Buffett starts to buy back large amounts of stock when WFC is trading at these levels, this is what I think should happen:
I am not tech savvy enough to cut and paste Mr. Buffett’s face over Sewell Avery’s. But yes, if he chooses to buy back BRK stock (right column) over WFC shares (the left column in above table), that would mean he has finally lost his marbles. Call in the troops. Take him away!
Back to Bullet Points
- While Mr. Market seeks comfort in the safety of bonds and alternative investments that promise to make money year in and year out no matter the environment, Mr. Buffett understands that this is nonsense. Bonds are bubbled up right now and have a lot of risk, and again, the history of folly in the investment world is often caused by not only the need to get rich quick, but to get low-risk returns. The promise of consistent profitability, low volatitily and non-correlation manufactured by financial engineering often delivers on the promise for a time until it blows up. The cure is often worse than the disease. Mr. Buffett understands this very well.
- While Mr. Market sees the end of banking as a profitable business, Mr. Buffett disagrees. He concedes that the days of 20x leverage and 30% ROE are over, but it’s still a very good, profitable business. We don’t need another bubble for banking to be a good business (again, look at the above table!).
- Mr. Buffett doesn’t worry about top-line growth as he sees that it will come when the economy recovers. He sees a housing recovery as the key to lower unemployment and a stronger economy and he sees that coming, eventually. He has tried to time the recovery before and got it wrong, but he still has no doubt it will come.
- Even if the top line doesn’t grow too much, Mr. Buffett understands that if you have a profitable business model and excess capital, it can be returned via stock repurchases. He doesn’t need a company to grow; intrinsic value per share of a business can grow a lot without a lot of top line growth. If you earn 15% ROE and see no top-line growth and just repurchase shares with the profits and you do so at book value, you can grow your BPS 15% (well, even if you don’t repurchase shares BPS will grow 15%, but then ROE will go down next year if you can’t deploy that 15% at 15% ROE). If you pay 2x book, you still grow BPS at 7.5% (yes, it would be dilutive to BPS, but can still grow it. If my other other post is right, then you can still grow intrinsic value per share even if you buy stock above BPS). If management is competent, businesses can be managed to enhance per share intrinsic value. There are a lot of value creating levers.
- Mr. Buffett is not worried about the riskiness of banks. He has been investing in banks for decades and knows banking better than most bankers. A few obsessed journalists writing scary stories about how opaque the banks are (who probably have never even read a 10-k all the way through) is not a concern. Some of these writers have only lived through one cycle. Buffett (and to a lesser extent, Dimon) have seen many cycles and understands that it’s the same thing over and over.
- He agrees with Dimon who pointed out when people were skeptical of the Fed stress tests that they have actually just lived through a real-life stress test and passed with flying colors. WFC too has passed this real-life stress test amazingly well. People will argue that that is thanks to TARP, but even the Geithner hating, big bank busting Sheila Bair has said that WFC and JPM are well managed and weren’t in trouble and didn’t need TARP. It’s amazing that these banks did so well in a 100-year crisis; particularly when WFC was one of the biggest mortgage lenders and the bust centered on residential real estate.
- Mr. Buffett finds it ironic that people say banks were bailed out by the government (so won’t invest in them) but are fine with investing in hedge funds, private equity funds etc. When they bailed out the big banks, they bailed out the financial system. If the financial system failed, many hedge funds and other investors would have lost a ton of money; look what happened to prime brokerage clients at Lehman, clients at MF Global etc.
- Mr. Buffett finds it ironic that banks are accused of being opaque when they consistently file hundreds of pages of material with the SEC every year, and yet people invest in hedge funds with nowhere near the disclosure. Dimon said the other day something like, “We file a 400 page 10-K every year, what do you want to know?” Perhaps if Madoff had to file with the SEC (in similar detail), people wouldn’t have lost money. Mr. Buffett has been reading annual reports for more than half a century. I doubt most journalists have even read one all the way through. (I don’t blame them; much of the low quality in journalism is due to deadlines and quotas; I don’t think any journalist is any dumber than anyone else. It’s just that if you are an investor thinking about spending billions of dollars to buy into a stock, you are going to do a little bit more work on it than someone who needs to get an article to his editor by 2:00 pm Thursday. This is why TV journalism can be even flakier; their deadlines may be shorter and they need to fill airtime with stuff. And you just can’t put out a lot of high quality stuff all day. I am always shocked at how little financial journalists seem to know and understand even when many have more years in the business than me. Are they that stupid? I realized it’s not that at all. They don’t have a deep understanding because they never dig that deep as they don’t have the time. They only have to dig deep enough to get the story out. Then it’s on to the next story. That’s why my sister understands more about business than some of these so-called veteran journalists; it’s not the journalist’s job to understand. It’s their job to sell newspapers, magazines, and fill air time) Oftentimes, you’re better off going with the guy with decades of experience and someone who probably has read every single filing for hundreds of companies going back decades over some guy rushing out an article for a deadline where the ‘story’ is already predetermined (and probably the headline too).
Anyway, this can go on and on so I’ll stop here. I thought it would be an interesting post for some (but same old, same old for us value people).