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.
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