Historically, Berkshire Hathaway (NYSE:BRKA)(NYSE:BRKB) — the conglomerate holding company run by Chair and CEO Warren Buffett and Vice Chair Charlie Munger — has achieved the rare and elusive feat of beating the market. The per-share book value of Berkshire Hathaway has increased more quickly than the S&P 500 equity index for every five-year period since 1965, boasting a compounded annual gain of 19.7 percent compared to 9.4 percent for the market, including dividends.
The track record is nothing short of astonishing, and it has earned Buffett a legendary reputation that would seem fictitious if it weren’t backed up by data. Research into Buffett’s investing strategy conducted by the National Bureau of Economic Research indicates that far from simply being lucky, Berkshire Hathaway has managed to produce outsize returns with minimal risk consistently for at least the past 30 years.
Buffett has done this by adhering to a fairly simple overarching strategy: Buy great companies (or stakes of those companies) at good prices. The value investing paradigm, first championed by Benjamin Graham and David Dodd at the Columbia Business School, which Buffett attended, saturates Buffett’s decision-making process.
Investors large and small turn to Buffett and the philosophy he champions for guidance in their own investment decisions. While playing follow the leader is generally not a winning strategy, there is something to be said for taking a look at the big investments Buffett makes. Here’s a look at his largest holding, Wells Fargo (NYSE:WFC).
1. Great company at a good price, or a good company at a great price?
In 1989, Buffett wrote to Berkshire Hathaway shareholders that, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” He was speaking about “bargain-purchase” folly, one of the traps of the value investing philosophy that can be surprisingly difficult to avoid. In his 1989 letter, he admits to falling into it himself with, among other things, the purchase of the Berkshire textile manufacturing company. He was “enticed to buy because the price looked cheap,” but as he went on to say, the deal wasn’t such a bargain after all.
“Now, when buying companies or common stocks,” he wrote, “we look for first-class businesses accompanied by first-class managements.” Ostensibly, this means Wells Fargo. Buffett first invested in the bank in 1989, and has been seriously adding to his position for nearly a decade. At the time of his first purchase, Buffet told Berkshire shareholders that, “With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen.” Reichardt was president of the bank from 1978 to 1984, and chair the institution until 1994; Hazen succeed Rechardt as president, until 1998, and later chair, until 2001.
Buffett owned 5 million shares of Wells Fargo stock in 1990 for a cost of $289.4 million. He’s bought in at a number of different price points since, but his philosophy appears to have remained the same. He’s continued to add to his position based on the idea that Wells Fargo is one of the best banks in the business being run by some of the best people in the business. At the helm right now is John Strumpf.
Back in 1990, Buffett wrote that, “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.”
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2. Some bets on housing are good bets
The late 2000s wasn’t the only period of time during which the housing market was, let’s say, frothy. Writing in 1990, Buffett mused that, “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.” Then, as now, Wells Fargo was a leading real estate lender, and (then, as now) this exposure was a red flag for many investors.
That year, fears of disaster in the west coast market contributed to a 50 percent decline in Wells Fargo stock price. Buffett, cool as a cucumber, bought more. “We welcomed the decline because it allowed us to pick up many more shares at the new, panic prices,” he told shareholders.
Some of the same thinking no doubt resurfaced over the past decade as the housing market inflated and burst, and Buffett added to his position in Wells Fargo throughout it all. Buffett has bet big — sometimes a little too optimistically — on the recovery of the housing market, saying in 2011 that “Housing will come back – you can be sure of that.” What better way to capitalize on the trend than to own a sizable share of the largest retail mortgage lender in the country?
The bank’s exposure to housing hasn’t been without cost, though. At the end of 2013, Wells Fargo announced that it would have to pay $591$ to Fannie Mae in order to settle claims that it sold defective mortgages during the financial crisis of 2008.
3. The recovery of the financial industry is real
Buffett is often seen as a different kind of investor than those who make up the nebulous Wall Street crowd. His approach is so well-grounded in common sense, his personality so agreeable, that he is often not mentioned in the same breath as Wall Street. But Buffett’s stake in Wells Fargo, and his enormous stakes in a number of other major banks, are clear, and he is straightforward about his position on the financial industry as a whole.
“The banks will not get this country in trouble,” Buffett told Bloomberg’s Betty Liu early in 2013. “I guarantee it. The capital ratios are huge, the excesses on the asset side have been largely cleared out.” At the time, Buffett had multibillion dollar investments in four of the seven largest U.S. lenders by assets. “Our banking system is in the best shape in recent memory,” Buffett told Bloomberg.
Buffett’s comments didn’t pass without criticism and many financial institutions have had to pay billions to settle the lawsuits that emerged in the wake of the crisis, but the investments speak for themselves. Buffett has banked billions from his dealings with America’s largest financial institutions, including more than $5 billion from his deal with Bank of America (NYSE:BAC) and about $2 billion from his deal with Goldman Sachs (NYSE:GS).
Buffett was greedy when other people are fearful and served as a white knight lender to many financial institutions during the crisis. The result was an enormous win for Berkshire.
4. What it all comes down to
At the end of the day, the success of Buffett’s investment comes down to the price of Wells Fargo stock. On February 14, shares were trading at $46.13, up over 30 percent on the year, up nearly 50 percent over the past two years, and up nearly 190 percent over the past five. The bank, and its stock, performed relatively well throughout the financial crisis and over a 10-year time frame, only JPMorgan (NYSE:JPM) really compares.
Analysts hold a mean price target of $49.01 and a median price target of $50 on the stock, representing potential upside of about 10 percent.