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I am an author of books related to the decision framing and optimizing processes of Buffett and Munger. These books are available at and: With integrity and patience, we can also earn superior profits by carefully evaluating facts and... More
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The Four Filters Invention of Warren Buffett and Charlie Munger
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  • Wells Fargo (WFC) Competitive Advantages


    Wells Fargo is a well-managed, high-return banking operation in which Berkshire Hathaway increased its ownership to around 11%. About one-sixth of the position was bought in 1989, the rest in 1990 and 2010.

    Buffett wrote: "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 when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the foolish behavior of their peers. 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."

    With Wells Fargo, Buffett was thinking about "the best managers in the business, Carl Reichardt and Paul Hazen." He liked the pair of managers. Both managed costs wisely when profits were at record levels as well as when they are under pressure. Both managers did what they understood and did not let their egos determine what they attempt.

    Buffett's Berkshire purchases of Wells Fargo in 1990 were helped by investors' flight away from bank stocks. Berkshire purchased a 10% interest in Wells Fargo for $290 million, which was less than five times after-tax earnings. Interestingly, Buffett did a similar move to buy more Wells Fargo stock in 2010 for similar bargain reasons.

    Wells Fargo is big, and it has been earning higher than average returns on equity and returns on assets. The purchase of one-tenth of the bank has been described as roughly equivalent to Berkshire buying 100% of a $5 billion bank with identical financial characteristics.
    Buffett described these risks. California banks face the specific risk of a major earthquake that could destroy banks. Another risk is a systemic risk. This almost came true during the great recession of 2008 and 2009. Buffett described this as: "the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run."

    In the recent financial crisis, WFC and other major banks were forced by the U.S. government to undergo stress tests and take infusions of cash in an effort to moderate the great credit crisis. Charlie Munger said Wells Fargo and U.S. Bancorp avoided many of the banking mistakes that led to the worldwide credit crisis and recession.

    Buffett wrote that a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. In late 1980s, the market's major fear was that West Coast real estate values would tumble because of overbuilding. Because WFC was and is a leading real estate lender, Wells Fargo is thought to be vulnerable. Fears of a California real estate disaster caused the price of Wells Fargo stock to fall almost 50% in 1990. He welcomed the decline because it allowed him to buy more shares at the new, panic prices.

    Wells Fargo & Company (NYSE:WFC), is the fourth largest bank holding company in the United States. It is best classified as a diversified financial services company with over 80 distinct businesses. WFC offers a full range of financial products and services. It targets all types of clients in all 50 states and the District of Columbia.

    In 2010, Wells Fargo earned a total of $85 billion in total revenues and a net income of $12.4 billion. After acquiring Wachovia, it became the nation's largest mortgage lender and the second-largest diversified financial service deposits firm in the United States.

    As part of the TARP deal to raise enough cash for the Wachovia rescue acquisition, Wells Fargo's sold $12.6 billion in common stock and $25 billion in preferred stock to the US Government through the $700 Billion Troubled Assets Relief Program (TARP).

    Like all major banks, Wells Fargo has been negatively impacted by the credit crunch and the economic decline. However, Wells Fargo was not forced to write down large losses on its assets.

    Wells Fargo raised $12.25 billion in a stock sale to help repay the $25 billion in Troubled Assets Relief Program (TARP) crisis money. Although this diluted Wells Fargo's shares by approximately ten percent, it allows the bank to avoid paying an annual dividend to the government of $1.25 billion. This also frees WFC from added government oversight.

    Wells Fargo separates its businesses into three main segments for revenue reporting purposes: 1.) Community Banking, 2.) Wholesale Banking, and 3.) Wealth, Brokerage, and Retirement. Wells Fargo's Community Banking business serves small business clients as well as retail customers. It also provides a wide range of services in investment, insurance, and trust services to high-net-worth individuals.

    WFC offers its products through a variety of channels, including the company's regional banking branches, over 6,700 ATMs, website, and telephone banking service. Wells Fargo's large credit card business, now part of its Community Banking, has issued over 7.7 million credit cards and over 20 million debit cards. This makes it the second largest debit card issuer in the U.S. As a credit card issuer, it charges interchange fees, interest on outstanding customer balances, and fees such as late or missing payment fees, exceeding credit limit fees, and monthly or annual membership fees.

    Wells Fargo's Wholesale Banking Group serves business clients with annual sales exceeding $10 million. Wholesale Banking is responsible for a line of corporate, commercial, and real estate banking products and services. This includes institutional investments, employee benefit trusts, investment banking, construction loans, and insurance.

    After the Wachovia Bank acquisition, WFC was also able to expand its product services to include investment banking, equity trading, fixed-income sales and trading, and equity and fixed-income research.

    Wells Fargo has also teamed up with Visa (NYSE:V) to pilot test a mobile payments system. Competition for mobile payments dominance between credit card companies and telecom companies may have huge implications for future earnings as this market develops.

    Wells Fargo's mortgage lending business was hit by slow growth and falling residential real estate prices. The number of total housing starts fell about 63% since peak levels during the end of the housing boom. However, Wells Fargo dealt with mortgage setbacks relatively well due to its wide diversification in product offerings.

    The housing slowdown is often attributed to the collapse of the subprime lending market. Wells Fargo fared better than most competitors in the mortgage business because its mortgages are predominately prime and near-prime. As a result, Wells Fargo did not experience the high rates of default seen in the subprime market. Wells Fargo has avoided much of these losses by deciding not to extend or purchase option adjustable rate mortgages (option ARMs). However, the Wachovia Bank, acquired by Wells Fargo at a bargain, took part in Option ARMs and subprime lending.

    With 6,795 branches and $760 billion in total domestic deposits, Wells Fargo focuses its business operations on the domestic U.S. market. Its major competitors include Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM), and Citigroup (NYSE:C).

    Wells Fargo is strongly focused on the United States market. Wells Fargo has less international exposure than its top competitors. While this does allow Wells Fargo to focus its resources on gaining greater market share within the U.S., it is more vulnerable to U.S. economic cycles. WFC does not have foreign markets to buffer domestic performance.

    According to John Stumpf, Chairman and CEO, Wells Fargo's biggest competitive advantage is its employees. The company looks for talents in different cultures and backgrounds and provides them with the necessary training. Wells Fargo's culture recognizes and rewards an outstanding performance. As a result, twenty seven years is an average tenure for Wells Fargo's wholesale leadership members.

    Wells Fargo also focuses on customer retention. It has over ten year long relationships with forty percent of its customers. Such high retention rates enable cross-selling of products. In 2009, an average number of products per wholesale relationship were 6.47, a steady increase from 4.84 in 2003.

    Recently, WFC's 5Yr Net Profit Margin (5-Year Avg.) is approximately 15.4%, while the industry Net Profit Margin (5-Year Avg.) is 16.5%, and the S&P Net Profit Margin (5-Year Avg.) is 11.5%.

    Wells Fargo also uses its size and financial reserves as a competitive advantage. The current economical crisis has shown that no bank is too big to fail. Therefore, Wells Fargo will have to stay with its core values by focusing on its current customers and refrain from assuming too much risk in the mortgage market.

    Bud Labitan
    author of "The Four Filters Invention of Warren Buffett & Charlie Munger" and "Moats : The Competitive Advantages of Buffett & Munger Businesses"

    Disclosure: I am long BRK.A, BRK.B.

    May 20 12:58 PM | Link | Comment!
  • Free 20 Chapter Version Of The MOATS Book

    Free 20 chapter version of the MOATS book

    Many volunteers contributed research to this fine book about business competitive advantages. In an effort to raise awareness for MOATS : Competitive Advantages of 70 Buffett & Munger Businesses, I am releasing a free 20 chapter abridged version over the internet in pdf form.

    You can download your copy here:

    Feel free to respond with constructive criticism. Perhaps we can include your findings in the second edition next year.

    MOATS may currently be the best business book that describes the competitive advantages of profitable businesses. However, being a self-published project without a big publishing house marketing effort, it has been floating under the radar of awareness of serious financial journalists. Therefore, this free 20 chapter abridged version is released to get people talking about it, as well as critically reviewing its content.

    MOATS describes the nature of 70 selected businesses purchased by Buffett and Munger for Berkshire Hathaway Inc. MOATS is a very useful resource for investors, managers, students of business. Since its subject matter has proven success, MOATS may become a useful practical text in businesses schools around the world. MOATS also looks at the sustainability of these competitive advantages in each of the 70 chapters. The author extends a special thanks to Professor Phani Tej Adidam, Ph.D. Chair of the Department of Marketing and Management and Director of the CBA International Initiatives at University of Nebraska at Omaha. Thanks are extended to Richard Konrad, CFA, Dr. Maulik Suthar, and Scott Thompson, MBA for sharing their thoughts, analysis, and feedback.

    The 70 Businesses covered in MOATS:

    Acme Brick Company, w Adam Ward
    American Express Co. (NYSE:AXP), Dr. Maulik Suthar
    Applied Underwriters, w Adam Ward
    Ben Bridge Jeweler, w Beryl Chavez Li
    Benjamin Moore & Co., w Mr. Jack Wang CPA
    Berkshire Hathaway Group, w Brian Greising & Rick Mayhew
    Berkshire Hathaway Homestate Companies, w Beryl Chavez Li
    BoatU.S., w Peter Chen
    Borsheims Fine Jewelry, w Tariq Khan.
    Buffalo News, Bud Labitan & Peter Stein
    Burlington Northern Santa Fe Corp. w David Leoy.
    Business Wire, w Larry Harmych.
    BYD, w Kevin Walsh.
    Central States Indemnity Company, w Azalia Khousnoutdinova,
    Clayton Homes, w Erin Sestak.
    Coca Cola (NYSE:KO) w Sebastian Jung,
    ConocoPhillips (NYSE:COP), w Adam D. Studts, PE.
    CORT Business Services, w Erin Sestak.
    Costco Wholesale (NASDAQ:COST), w Jubin Jacob, AUC-SOM
    CTB Inc., w Todd Sullivan.
    Fechheimer Brothers Company, w Ben Albaitis.
    FlightSafety, w Peter Stein
    Forest River, w Richard Konrad, CFA
    Fruit of the Loom®, Dr. Maulik Suthar
    Garan Incorporated, w Dr. Edwin Fuentes
    Gateway Underwriters Agency, assigned Daniel Rudewicz, CFA
    GEICO Auto Insurance w Florian Beil,
    General Re, w Raghu Dasari, & Theodor Tonca
    H.H. Brown Shoe Group, w Mervyn H. Teo
    Helzberg Diamonds, w Natalja Callahan
    HomeServices of America, w Sebastian Jung
    IBM, w Tim Bishop & Peter Stein
    International Dairy Queen, Inc., w Tariq Khan
    Iscar Metalworking Companies, w Kevin Walsh
    Johns Manville, w Manpreet Singh Saran
    Johnson & Johnson (NYSE:JNJ), Beryl Chavez Li
    Jordan's Furniture, w Zehao Sun.
    Justin Brands, Dr. Maulik Suthar
    Kraft Foods (KFT), w Andrea Tagart.
    Larson-Juhl, w Tim Bishop
    Lubrizol, w Scott Thompson, MBA.
    M&T Bank Corp (NYSE:MTB), w Cliff Orr & Richard Konrad, CFA
    Marmon Holdings, Inc., w David Lau & Theodor Tonca
    McLane Company, Dr. Maulik Suthar,
    Medical Protective, w Michael Murillo
    MidAmerican Energy Holdings Company, w Dr. Maulik Suthar & Brian Bernardino, JD
    MiTek Inc. w Mr. Jack Wang CPA
    Moody's (NYSE:MCO), w Raghu Dasari
    National Indemnity Company, w Jen Iwanski & Rick Mayhew
    Nebraska Furniture Mart, w Julie Rosenbaugh, Theodor Tonca, & Shouryamoy Das
    NetJets®, w Christian Labitan
    PacifiCorp., w Beryl Chavez Li
    Precision Steel Warehouse, Inc., w Adam D. Studts, PE & J.T. Loudermilk, MBA
    Procter & Gamble (NYSE:PG), w Beryl Chavez Li
    RC Willey Home Furnishings, w Azalia Khousnoutdinova
    Richline Group, Daniel Doyon
    Scott Fetzer Companies, Cliff Orr & Hoang Quoc Anh, Vietnam
    See's Candies, w Jen Iwanski
    Shaw Industries, w Daniel Doyon & Richard Konrad, CFA
    Star Furniture, w Pamela A. Quintero, MBA
    The Pampered Chef® w Julie Rosenbaugh
    TTI, Inc., w Peter Chen
    United States Liability Insurance Group, w Stephen Chan & Colin Farrier
    US Bancorp (NYSE:USB), w Richard Konrad, CFA
    USG Corp (NYSE:USG), w Richard Konrad, CFA
    Wal-Mart (NYSE:WMT) w Florian Beil
    Washington Post (WPO), w Andrea Tagart & Richard Konrad, CFA
    Wells Fargo (NYSE:WFC), w Natalja Callahan.
    Wesco Financial Corporation, w Stephen Chan
    XTRA Corporation, Bud Labitan

    Disclosure: I am long BRK.A, BRK.B, JNJ, AXP, USB, PG.

    Additional disclosure: Many volunteers contributed research to this fine book about business competitive advantages. In an effort to raise awareness for MOATS : Competitive Advantages of 70 Buffett & Munger Businesses, I am releasing a free 20 chapter abridged version over the internet in pdf form.

    May 18 10:01 AM | Link | Comment!
  • Does GM Make For An Intelligent Speculation?

    Does GM make for an intelligent speculation?

    Since it is backed by the U.S. government, let's do a rough estimation. Starting with a base estimate of annual free cash flow at a value of approximately $3.3 billion and the number of shares outstanding at 1.57 billion shares, we used an assumed free cash flow annual growth of 6 percent for the first 10 years and assume zero growth from years 11 to 15. Review the free cash flow record here:

    The resulting estimated intrinsic value per share (discounted back to the present) is approximately $29.34.

    Market Price = $21.94
    Intrinsic Value = $29.34 (estimated)
    Price To Value (P/V) ratio = .75 and the estimated bargain = 25. percent.

    Before we make a purchase, we must decide (filter No. 1) if GM is a high quality business with good economics. Does GM have (filter No. 2) enduring competitive advantages, and does GM have (filter No. 3) honest and able management?

    Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. In terms of Opportunity Cost, is GM the best place to invest our money today? I do not think so. However, since Mr. Combs' and Mr. Weschler's compensation is based on three-year performance, I think this was a bet made by one of them and approved by Mr. Buffett.

    I agree with Dr. Maulik Suthar's take on an upswing in a cyclical industry and consideration of a leaner GM backed by the US. I posted some ideas at the Facebook ISVI site, and Idea #5 is to look at this interesting play as an "insurance policy" on Buffett's bet that the US economic recovery continues. While $500+ million is a mini stimulus on one business, GM, it also carries the weight of Buffett and Berkshire's reputation... more upside than downside. So, should we reframe and think of GM as a multinational company with a profitable primary market in China and semi-profitable secondary markets in the US and other parts of the world? Obviously they see value there that we do not yet see.

    I can see GM doing well for the next three to four years as a restructured entity. I do not yet see any long-term competitive advantages at GM.

    Bud Labitan
    author of "The Four Filters Invention of Warren Buffett & Charlie Munger" and "Moats"

    Disclosure: I am long BRK.A, BRK.B.

    May 18 9:59 AM | Link | 1 Comment
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