After years building and protecting a record $146bn pile, the Oracle of Omaha has finally started to spend it.
Since mid-July, Buffett’s Berkshire Hathaway [BRK] conglomerate forked out $2.1bn on Bank of America [BAC] shares, bolstering his stake in the bank to 11.8%.
It’s an interesting move from Buffett, who has made it clear since 2016 that he’s biding his time until the right opportunity comes along. Many people thought that opportunity would come when COVID ravaged the markets in March, but the man known for “buying the dip” kept his cards (and cash) close to his chest.
So, why has he moved now, and what’s got him so excited about Bank of America?
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To understand, we need to take a moment to reflect on 89-year-old Buffett’s legendary career.
The father of value investment, Buffet has built his $72bn personal fortune steadily over six decades on the principle of buying stocks in companies that evidence solid fundamentals, strong earnings power and the potential for continued growth.
He likes businesses with clear, solid goals rather than a woolly philosophy — a strategy that protected him when the dotcom bubble burst. He also likes businesses that maximise shareholder value by redistributing funds as dividends over reinvesting in the company.
He tends not to get sucked into trends or leap onto bandwagons, and is naturally suspicious of spikes and the danger of overvaluation — hence why Buffett owns 74 million shares in General Motors, but not a single cent of Tesla. “If I get an idea next week,” he once said. “I’ll do something. If not, I won’t do a damn thing.” For Buffett, slow and steady tends to win the race.
During the coronavirus crisis, he and his 96-year-old business partner Charlie Munger exhibited their fondness for cash in turbulent times as they watched from the sidelines. Munger described March’s mayhem as “the worst typhoon that’s ever happened,” simultaneously acknowledging its devastating effects while writing it off as a storm that would pass. “We just want to get through the typhoon,” Munger told the Wall Street Journal“and we’d rather come out of it with a whole lot of liquidity.”
Buffett famously doesn’t panic, even amid an uncontrollable pandemic, because he sees his strategy as buying companies, rather than investing in stocks. He once said: “The real question is: has the 10-year or 20-year outlook for American businesses changed in the last 24 or 48 hours?”
He advises Berkshire Hathaway investors not to panic either, telling them at this year’s virtual annual shareholders’ meeting: “I don’t think most people are in a position to pick single stocks. I think people are much better off buying a cross-section of America and just forgetting about it.”
Buffett practices what he preaches. He likes, for example, the broadness of low-cost index funds such as the S&P 500, but that doesn’t mean he’s completely averse to a shorter-term bargain.
Arguably the most famous example of this strategy came in 2008. As the world surveyed the wreckage of the collapsed Lehman Brothers, Buffett boldly ploughed $5bn into preferred shares in Goldman Sachs. The high-profile vote of confidence boosted the company’s share price so much that within three years, Goldman Sachs paid him $5.5bn to get the preferred shares back — and in 2013, Buffett exercised an option to acquire $2.15bn worth of the bank’s shares.
This relatively short-term profit was still underpinned by Buffett’s guiding principle, though: prioritising the value of the company over its share price. He could see that while the other banks lay in tatters, Goldman Sachs had the ability to come through the crisis.
Banking on America
Which brings us back to Bank of America, which Buffett first began buying in 2011.
Banks today are facing unprecedented headwinds, not least having to write off billions of dollars of bad debt. The Bank of America has itself reported $5bn in loan loss charges during the coronavirus pandemic so far, and its shares have lost more than 25% of their value this year.
Even so, the bank is underpinned by solid fundamentals. Bank of America’s return on tangible equity has ranged between 8% and 14% since 2015, and it is well capitalised. Its CET1 ratio — which compares its capital and risk-weighted assets to determine its ability to withstand financial distress — is 11.6%, comfortably above its required 9.5%, suggesting a solid foundation for the years ahead. The ever-careful Buffett has seen an opportunity to buy shares for less than book value and less than 10 times earnings — so why wouldn’t he?
Contrast this with his current stance on the aviation industry, where Buffett sees no future – he sold his “entire positions” in the US’s four largest airlines in April and has said a coronavirus vaccine would be necessary before he considered investing again. Such a cautionary, bearish move, combined with reluctance to swoop, saw Berkshire Hathaway’s second-quarter earnings surge 86% to $26.3bn.
Buffett’s strategy, he once told shareholders, came from his grandfather Ernest, who had “an extreme aversion to financial adventurism”. Buffett hasn’t just applied this to his investments. According to Business Insider, Warren Buffett has lived in the same house for decades, drives a modest car and most mornings gets breakfast for around $3 at his local McDonald’s.
He also follows his grandfather’s advice to keep his cash where he can see it. At his shareholder meeting in 2010, Buffett quoted a letter written by Ernest in 1939 which advised everyone to have a reserve because “the mental satisfaction of having $1,000 laid away where you can put your hands on it is worth more than what interest it might bring”.
It’s a philosophy that has served Warren Buffett well, never more so than this year. He’s sat back and observed, assessing the value of companies and sectors rather than the volatility of shares – but with a cash stockpile, that means he’s always ready to maximise an opportunity. As Buffett approaches his 90th birthday this month, he believes solid opportunities will keep coming.
“Nothing can stop America when you get right down to it,” he says. “I will be on America the rest of my life.”
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