Even for Warren Buffett, there are limits to how many good
stocks one can follow. According to his latest quarterly filings
for his firm
Berkshire Hathaway (NYSE:
BRK-B
)
, he's pared his portfolio to just 25 holdings by December 31, the
lowest level in several years, and down from 33 three months
earlier. He's not running form the market, though. In fact, the
total value of his portfolio rose to $52.6 billion in the fourth
quarter from $48.6 billion at the end of the third quarter, even as
Berkshire owned fewer names.
Most intriguingly, Buffett's tightening his focus. Case in point:
Berkshire's decision to sell off the remaining 5 millionshares of
Bank of America (NYSE:
BAC
)
, worth about $745 million, while averaging up on
Wells Fargo (NYSE:
WFC
)
.
Too many headaches
You can understand why he fell out of love with BofA. The bank
seems to be a magnet for bad news, from botched acquisitions to
sloppymortgage processing. The bank's missteps are becoming so
well-known onMain Street that Buffett presumably fears that BofA's
long-term reputation has suffered.Shares of BofA rallied nearly 30%
in December, which is probably all the excuse Buffett needed to get
out of the stock.
A cleaner story
One thing has been clear about Wells Fargo: the San Francisco-based
bank seems to have adroitly sidestepped a great deal of the
potholes besetting the banking sector the past few years. It hasn't
been immune to the powerful forces of a downeconomy , but at least
its management hasn't been pilloried by the press (as was the case
with BofA and
Goldman Sachs (NYSE:
GS
)
, and it didn't make life-threatening bad investments that led to
government handouts (see
Citigroup (NYSE:
C
)
).
The question for investors: Why is Buffett boosting his stake in
Wells Fargo to a recent 342.6 million
shares
(worth nearly $12 billion)? The answers become clear once you dig a
little deeper...
Buffett bought shares throughout the fourth quarter on the heels of
an impressive third quarter report that saw a wide range of
operating metrics get healthier: Non-performing loans stabilized,
exposure to themortgage processing scandal appeared contained, and
most important, early stage loan delinquencies -- a key harbinger
of any future problems -- showed real improvement. All of this led
to a bottom-line result that exceeded forecasts by nearly 10%.
Fourth-quarter results were simply quite good, though not above
plan, as had been the case in the third quarter. But Buffett's not
buying this bank for its near-term performance. He has a long-term
view in mind. And for Wells Fargo, it looks quite bright. A wide
range of business activities should get stronger and stronger in
the next few years -- assuming theeconomy doesn't fall back.
For starters, interest rates will eventually rise -- which should
help to widen the bank's spreads between lending and borrowing.
Right now, Wells Fargo's net interest spread is about 4%, though
that could rise to 5% or 6% in a firmer
economy
, if history is any guide.
Second, Wells Fargo has managed to post very impressive results
even as the housing sector remains moribund. As housing eventually
rebounds, Wells'
mortgage
origination business should once again become aprofit machine.
Wells Fargo has $40 billion of financial firepower sitting unused
as lending remains slow in this economy. Once the bank steps up its
lending, that $40 billion can earn far higher returns.
Add all this up, and analysts will start to look ahead to what
Wells Fargo may earn in a better economy. Per-share profits rose
from $1.75 in 2009 to $2.21 in 2010, and look headed up to $2.75
this year. Analysts at Guggenheim Securities think
"normalizedearnings ," which the bank may generate within a few
years, could hit $4.25 a share without adding any incremental
business.
Action to Take -->
This is precisely why Warren Buffett is boosting his bet on Wells
Fargo. Even after a solid run, shares trade for less than 10 times
projected 2012 profits and closer to seven or eight times
likelyearnings when the economy is truly healthy.
That
earnings
power could spill over to thedividend as well. Restrictions put in
place when the TARP program was in effect have limited the
annualdividend to just $0.20 a share, good for a paltry 0.6%yield .
Analysts at Sterne Agee think the
payout ratio
may eventually rebound to 30%, implying a $1.08
dividend
based on 2012profit forecasts. This would push theyield above 3%.
As the economy improves, the dividend could move even higher,
creating the impetus for adividend yield above 4% when measured
against today's stock price.
Shares of Wells Fargo, which have steadily risen into the low
$30s, could surge up to the $40 mark once the economy is truly out
of the woods. Buffett's bullishness on that outlook is
heartening.
-- David Sterman
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.