When should one buy shares of a business? Well, I like Warren Buffett’s metaphor about swinging the bat in baseball. Basically, it says that you should swing only when the pitch is in the sweet spot of the strike zone. As a former tennis player, I like to think about when one should go for an approach shot and attack the net. You shouldn’t swing out on every ball and attack the net. You should not approach against balls that are hit deep or with a lot of topspin or which are hit low with pace and underspin. It just does not put the percentages of success at net in your favor. It would not lead to successful percentages against an apt opponent. There is a “sweet spot” associated with when a ball should be hit with spin and pace into a corner and come behind to attack the net. You want a shallow, not well struck ball that lacks spin and that lands around the service line and is bouncing up into your hit zone. Then you pounce.
In investing this means only swinging when you have a great franchise business with a strong economic position that is capable of achieving high returns on equity over long periods of time due to some moat. Also the company should be able to do this employing little debt and finally the company should be selling at a reasonable price. The business should be capable of growing earnings well into the future because it makes life tough for competitors. And it should be run by honest managers.
I think we have that with Well Fargo (NYSE:WFC). While their stock came down over 20% recently, Buffett himself believes their intrinsic value was slightly up last year. The case for Wells is:
- Wells has great management relative to other banks
- Wells trades at 10x earnings, which is reasonable
- Wells is growing at over 10% long term
- Wells has a long term ROE average of 17%.
Also, their earnings are consistent and this company is Berkshire’s (NYSE:BRK.A) #2 position. Of course, I would only buy it when it is selling “cheap” and only as a portion of a diversified portfolio and I would not make the position over 10% of the portfolio. By the way, the dividend is higher than the S&P average.
Disclosure: Author holds a long position in WFC