Warren Buffett is known for his ability to select investments with skill that perhaps not a single investor can duplicate. He’s also known for his loyalty to particular companies and brands. Think of his insistence on drinking Cherry Coke everywhere he goes, or how he seemingly always has a box of See’s chocolates on him, even when he’s halfway around the world.
Although Buffett is loyal to his brands, he’s not always loyal to his investment in those brands. Coke isn’t exactly setting the world on fire like it was 20 years ago, and See’s chocolates doesn’t need any more investment capital from the Oracle of Omaha. He couldn’t and probably shouldn’t add significantly to either of these investments.
One consistently growing stock in Warren’s portfolio is Wells Fargo. He’s added to it practically every few years after first buying a stake in the firm in following the localized, early 1990s real estate bust.
What Warren Loves about Wells Fargo
It isn’t all too often that Warren Buffett purchases part of a commoditized business. In fact, most of his investments are in highly differentiated brands (Coca-Cola, See’s Candies, and Pampered Chef), with the exception of those that can actually compete on price (Walmart, Geico, etc.)
Finance is so unbelievably commoditized. What’s the difference between a 30-year mortgage from bank A vs. a 30-year mortgage from bank B? Well, besides the potential differential between the annual percentage yield on the loan, nothing.
So how does Wells Fargo have an edge in banking? How would Buffett, a man who loves brands with value-added potential, justify an investment in one of the most commoditized businesses in the world?
Competing on Price
Wells Fargo can compete on price in a way that no bank could ever do. The unbelievable thing about banking is that, although there is little to differentiate one bank from another, operations and capital sourcing are vastly different from bank to bank.
Wells Fargo is primarily funded through deposits. It raises capital by borrowing funds from people who want the convenience of a savings or checking account. And because Wells Fargo has more locations in more places (more than 9,000 locations and 12,000 ATMs in 39 states) than most banks in the United States, Wells Fargo has scale. That scale translates into added-value for banking customers, who never need to change banks even if they move cross-country.
Wells Fargo’s scale, along with its happy customers, allows it to source funds at a price significantly lower than other banking institutions. In fact, Wells Fargo paid just 1.4% for its deposits over the past 10 year period compared to its closest competitors. Other banks were paying 1.75% for the same funds.
Simplicity Gives an Edge
Wells Fargo is a simple bank. It’s primarily involved in retail banking, and it doesn’t deal in exotic products to the same degree as its competitors. It’s a true savings and loan institution in the classical sense, borrowing funds inexpensively to lend to consumers through various mortgage offers, car loans, and personal lending operations.
Its ability to borrow funds at a price 20% lower than its competitors gives it a competitive advantage. Whereas another bank might be profitable issuing 30-year mortgages at 4%, Wells Fargo is profitable all the way down to 3.65%. People shop around for large loans, and invariably Wells Fargo can always win on price…if it has to. Otherwise, the difference between its borrowing costs and the costs of other banks is all profit.
Warren Buffett says that investors should “Always try to invest in a company that a monkey could run and still reward shareholders because eventually a monkey will run it.”
Wells Fargo could be run by a monkey. As long as it maintains its edge in sourcing capital, it can have all kinds of inefficiencies and problems elsewhere while still generating results. That’s the power of being a low cost provider.
Wells Fargo is in a position to reward investors for its impressive performance. The company is one of the best financed in the banking sector after absolutely leaping over the minimum stress test requirements put in place for major banks by the Federal Reserve. It now has the capacity to return as much as half its operating profits in the form of dividends or share repurchases.
The company currently yields 2.9% going forward, with a forward PE ratio of just over 8.
While the company certainly cannot grow like it did during the 1990s when Buffett first made his investment, it can grow on a per-share basis. Further share repurchases or dividend reinvestments allow investors the opportunity to invest in a company with an earnings yield of 12.5% per year.
So long as Wells Fargo maintains its ability to finance loans at a cost less than that of the competition, it has a durable competitive advantage that is unmatched. And with an earnings yield of 12.5%, it’s difficult to pass this one up as a safe, long-term play in the banking space.
As commoditized as banking has become, Wells Fargo has a very clear edge.
What do you think about Wells Fargo as an investment? What about banking overall?