Warren Buffett did an interview with Bloomberg TV this past Friday, and he once again spelled out his confidence in Wells Fargo (WFC). After praising JP Morgan (JPM) and CEO Jamie Dimon, Buffett started to express his confidence that Wells Fargo is the better choice:
"I like Wells Fargo better than anything by far. It complicates life when I am buying things as opposed to Berkshire Hathaway. I get what is left over…I like Wells Fargo better [than JPMorgan]. We have been buying Wells Fargo month after month for a lot of years. Among the big banks, I think it is the best."
Wells Fargo is a bit of a different kind of investment for Warren Buffett than some of his other holdings. When we look at some of Buffett's investments like Coca-Cola (KO), American Express (AXP), and Procter & Gamble (PG), we see an investment thesis driven by the belief that brand strength provides the foundation of an economic moat that is able to deliver solid risk-adjusted returns over the long term.
I would put Wells Fargo in "the other pile" with Wal-Mart (WMT) that represents Buffett's investments in companies that are the low-cost producers in the industry (although both Wells Fargo and Wal-Mart have brand equity as well). Of course, if we're potential investors in Wells Fargo, we should be asking these types of questions: What makes Wells Fargo the low cost producer in the industry? Why can it get a cheaper deposit base than Bank of America (BAC)? Buffett may own shares of US Bancorp (USB) in the Berkshire portfolio and 1,000,000 shares of JP Morgan in his personal portfolio, but what makes Wells Fargo his 10+ billion investment with over 400,000,000 shares under the Berkshire umbrella?
I'm sure there's a combination of reasons that can help explain what makes Wells Fargo the low cost producer in the industry, but I wanted to share a couple of passages from the Wells Fargo annual report that help shed some light on this question:
"If anyone tells you it's easy to earn more business from current customers in financial services, don't believe them. We should know. We've been at it almost a quarter century. We've been called, true or not, the "king of cross-sell." To succeed at it, you have to do a thousand things right. It requires long-term persistence, significant investment in systems and training, proper team member incentives and recognition, taking the time to understand your customers' financial objectives, then offering them products and solutions to satisfy their needs so they can succeed financially. You can't expect much progress in earning more business from current customers in just one quarter or even in a year or two. That's why many banks give up on it. The bad news is it's hard to do. The good news is it's hard to do, because once you build it, it's a competitive advantage that can't be copied. If it were easy, everyone would be doing it …
This year, we crossed a major cross-sell threshold. Our banking households in the western U.S. now have an average of 6.14 products with us. For our retail households in the east, it's 5.11 products and growing. Across all 39 of our Community Banking states and the District of Columbia, we now average 5.70 products per banking household (5.47 a year ago). One of every four of our banking households already has eight or more products with us. Four of every ten have six or more. Even when we get to eight, we're only halfway home. The average banking household has about 16. I'm often asked why we set a cross-sell goal of eight. The answer is, it rhymed with "great." Perhaps our new cheer should be: "Let's go again, for ten!"
Wells Fargo seems to be particularly strong at "entrenching" their client base. They're good at getting people to say, "My checking account is at Wells Fargo. My banking account is at Wells Fargo. My mortgage is with Wells Fargo. My car loan is with Wells Fargo. I use Wells Fargo for my brokerage services." This is a sharp contrast to the constant lament of Merrill Lynch brokers who are struggling to sell Bank of America products to their clients.
This plays a role in Wells' ability to be the low cost leader in the industry: not only does the bank exercise an economy of scale only rivaled by a half dozen or so other lending institutions in the country, but their sustained focus on expanding the number of relationships that each client maintains with the bank ensures that Wells Fargo does not have to offer much to keep their clients-once you have so many relationships with an institution, it would take a lot to get you to switch.
I appreciate CEO John Stumpf's attitude about expanding business with current customers: the bad news is it's hard to do. The good news is it's hard to do. I suspect this institutional philosophy plays a role in Buffett's decision to purchase and hold 400,000,000 shares of Wells Fargo. It has sealed its advantage as the low cost producer in the lending industry, and it would be very difficult for a competitor to displace Wells Fargo due to its large economies of scale and multi-year efforts to expand relationships and entrench the business of current customers.