The Devil And Warren Buffett... Why He Doesn't Sell His Financial Stocks

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Includes: BAC, BK, BRK.A, BRK.B, C, GS, USB, WFC
by: William Darusmont

Summary

Can we say anything about why he still owns them?

Is what's good for Buffett necessarily good for you as an investor?

Has Buffett changed his management style?

First, I borrowed the title from Stephen Vincent Benét's famous short story. It is not a disparaging remark about the Oracle, but it should make you question that just because Buffett buys or sells is not a reason for you to do likewise.

buffett While Buffett has held Wells Fargo (NYSE:WFC) since 1989, he only started buying more banks in 2008 at the depths of the crisis. With Bear Stearns 'given' to JPMorganChase (NYSE:JPM), and Lehman filing for bankruptcy, the entire global financial system in disarray and the broad stock market collapsing along with the financials, he may have figured that his investments would be worth little if he didn't help stop the decline. After all, if the entire global financial system imploded, what would his companies be worth. He wasn't as generous as you might think because he negotiated high rates of interest for his investments, even in 2010 when both Bank of America (NYSE:BAC) and Citibank (NYSE:C) saw their stock price plunge.

Let's look at the publicly held financials he owns through Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), leaving the insurance companies out since they aren't public entities (the number indicates rank of holding):

Wells Fargo #1: first bought in 1989, added to his position in 1990, and again in 2010. Over that period WFC outperformed BAC.

Goldman Sachs (NYSE:GS): 9/08, 'lent them' $5 billion in the form of 10% preferred stock (private placement to him alone) plus warrants to buy $5 billion common shares convertible at $115. Goldman wanted those 10% converts and pressured him to do the conversion when market price was over $150. In Q3 2015 he sold off some of his holdings.

Bank of America: bought $5 billion or 50,000 shares of 6% preferred that could be called at 105 (also a private placement), and also received 700,000 warrants convertible at $7.14.

In addition, he owns US Bancorp (NYSE:USB) and Bank of New York Mellon (NYSE:BK).

Since then, he has held all the stock, his (Berkshire's) huge profit, although still sizable, has shrunk. Also, whereas in previous sell-offs his stock was considered a safe haven, it is now paralleling the SPX, with the same kinds of gaps as the bank stocks, although smaller.

Besides those financials he also owns Wal-Mart (NYSE:WMT), Coke (NYSE:KO) #3, and American Express (NYSE:AXP) #5. The year is not off to a good start for him with the exception of Phillips 66 (NYSE:PSX) #7, while IBM and the others are showing weakness.

Buffett was the first that I know of to suggest you can diversify a portfolio with just 15 stocks. I don't think he meant with five major holdings in the same sector (banking). Add in AXP and there are six financials. WMT had been flat for more than two years until a very brief runup in the stock in the fourth quarter that culminated in a peak and rapid decline at the beginning of this year.

Overall, since mid-August BRK/B has been mirroring the SPX.

That is not to say I do not respect the man, but his investment style has changed dramatically since he made his first fortune by following the tenets of his mentors, Graham & Dodd. Consider the following quotes:

"We have more money than ideas…one place the money certainly won't go is to derivatives. There's no place with as much potential for phony numbers as derivatives."

Worse, was his 'partner', Charlie Munger's comment:

"To say that derivative accounting is a sewer is an insult to sewage."

These quotes came from his 1990 letter to shareholders:

"Derivatives are financial weapons of mass destruction, carrying dangers, while now latent, [but] potentially lethal. We view them as time bombs, both for the parties that deal in them and the economic system."

RBC Capital Markets bank analyst Gerard Cassidy says that "once we get back to normalcy [investors] will pick winners and losers by those that are managed the best." Many would argue that BofA has not been in that category over the last decade, but we are not yet at the point where that matters. "It's still a group call now," Cassidy says, and with that the case the lower-quality names have been the biggest winners.

...and this:

"Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled -- often on the heels of managerial assurances that all was well -- investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings."

"The banking business is no favorite of ours. When assets are twenty times equity -- a common ratio in this industry -- mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate."

"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."

"With Wells Fargo, we think we have obtained the best managers in the business."

I am not writing this for any reason other than to point out that his investment style has changed. Furthermore, in 2005, he went short against the dollar using derivatives. I had bought BRK in 2004 as a safe investment but he lost $1.2 billion on a $15 billion bet. Still, in his 2005 shareholder letter he assumed full responsibility adding that every one of his managers had hit their marks. How do you get upset with someone who has almost all of his assets in the stock and is far and away the biggest shareholder? I wasn't, but I sold out completely as he had changed his management style, something that is undesirable in any manager with a good track record. In retrospect, I was wrong, but sold for the right reasons.

Frequently, I hear the comment on BAC that Buffett hasn't sold so he must still like it. As reported above, his cost on those shares was $7.14. But regardless, if a stock isn't performing and you own that much of it (including his other financials), who do you sell it to? One trade in size and everyone knows who is selling, so he is in for the long haul, but based on his comments on banking it is unlikely he will buy more.

Also, when he bought GS in the crisis and BAC in 2011 when the stock price ($7.14) was very close to the low of March 2009 ($3.00), although it traded below that in both 2010 and 2011, he most likely expected a healthy dividend by now, something that has not come to fruition. However, the 10% and 6% preferreds provided the income he wanted and he is all about income to plow back into the portfolio.

The point is that it is meaningless to try to fathom whether he is happy with his holdings. Think of BRK as trying to turn around a container ship in a stormy sea…it can't be done.

I said I respect Buffett, and I do for this note signed by him and Charlie Munger when the non-voting Class B shares were issued: we do not recommend buying these securities as they don't represent value (that since they were already priced at the market), they are non-voting shares and neither myself or Charlie Munger would buy them. (paraphrased as well as I can remember…that said it was a blowout and rose immediately). Sometimes when you try to help people and know what you are talking about they won't listen, even if you are the Oracle of Omaha.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.