Warren Buffett: Bank of America Is a 'Fantastic Business'
Yesterday, I wrote an article explaining why I believed Warren Buffett (Trades, Portfolio) liked Bank of America (NYSE:BAC) more than any other financial business.
I noted that the Oracle of Omaha had made this financial institution the second-largest position in Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) massive equity portfolio, and he has been buying more of the stock in the past few weeks.
Commenting on why I thought Buffett was interested in Bank of America, I said that the company's economics were highly attractive, which may be the reason behind the trade. Specifically, I noted:
"Buffett has previously called banks good businesses because they can earn very high returns on tangible capital. These are just a sort of companies Buffett has sought out throughout his entire career. Bank of America's return on tangible equity has ranged between 8% and 14% during the past five years."
Buffett made these comments in February of this year as part of a wide-ranging interview with CNBC. When asked why he liked the sector so much, Buffett said, "banking is a good business if you don't do dumb things." He went on to add:
"The banks we own earn between -- the commercial banks -- earn between 12% and 16% or so on net tangible assets that's a good business. It's a fantastic business against the long term bond, you know at 2%. If you have a choice between a 2% instrument and a 12% instrument, which one is going to win?"
Buffett went on to add that he expects these high returns to continue, and he's not worried about low returns in the sector. The real question was, "if they do something massively dumb." This would be a deal-breaker for the billionaire CEO.
As he went on to explain, another reason why banking stocks looked attractive compared to the rest of the market was their cash returns. Here's what Buffett said on cash returns to investors in the CNBC interview:
"Bank of America's buying in a lot of stock every year. So, our ownership of the Bank of America this year probably will go up 7% o 8% without spending a dime. I'd like to own any business -- any good business -- where my ownership is up 7% to 8% every year without me spending any money and on top of it I get a dividend."
At the beginning of the year, Bank of America was targeting $37 billion of capital returns in 2020. That was equivalent to a shareholder yield of 12.2% at the time. In 2019, the ratio was around 14%.
These numbers have changed since the beginning of the year. The coronavirus pandemic has severely disturbed management's cash return plans for the year. However, we know that Buffett is not going to be buying based on what's going to happen in the next few months. It will be investing based on the bank's long term cash return potential.
If Bank of America can return to the levels of cash returns it promised in 2020 in the next two years, it would mean a 16.4% shareholder yield for investors on the current price. So, while the rest of the market seems to be concentrating on the near term risks for banks, Buffett is looking past the current headwinds. Based on these comments, it looks like the Oracle of Omaha is buying Bank of America for its future cash return and growth potential.
What's more, his comments about low bond yields compared to bank returns suggest that the sector is even more attractive today from a long term perspective than it was at the beginning of 2020.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
Why Warren Buffett Likes the 'Predictable' Earnings of Utilities
Why Does Warren Buffett Like Bank of America?
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This article first appeared on GuruFocus.
