Buffett's Investments: Wells Fargo & Company
Buffett bought Wells Fargo (Bank) in a tussle with a bear cartel who were hammering the stock in the midst of recession in 1990. Buffett was familiar with the banking business as he had earlier acquired Illinois National Bank. He understood that to sustain a bank just two things were important – sensible credit writing (whom to give loans and whom to not give) and low-cost operations.
Favorable long-term prospectus
Although banking is not the best in class business (high ROE earning), however, with efficient cost management, it can generate a 20% ROE according to Buffett, which is above average. Hence look for banks run by capable management who are focused on low-cost operations.
Carl Reichardt (Chairman) was responsible for turning around the bank. Although he did not announce any special dividends or share buybacks, he still ran the business for the benefit of its owners. He got the bank to the position of 10th largest bank in the U.S. by 1990.
Determine the value
The bank’s income statement was affected by the one-time loan loss provisions because of which its profitability got affected. Adjusting for the same, the company has a $1bn of earnings power.
The value of a bank is its Net Worth + Projected Earnings as a going concern.
- Earnings in 1990 = $600mn
- Yield of 30-year U.S. government bond = 9%
- Value of the bank = 600 mn/9% = $6.6bn
- Shares outstanding = 52 mn
- Per Share price = 6.6 bn / 52 mn = $126
- Purchase price for Buffet = $58
Therefore, Buffett purchased Wells Fargo at a 55% discount to its intrinsic value of $126 per share.