Warren Buffett has been a big fan of banks over the years, loading up his Berkshire Hathaway (BRK.B) with shares of Wells Fargo (WFC) , U.S. Bancorp (USB) , M&T Bank (MTB) and others and sticking with them through the mortgage crisis.
Financials are Berkshire's second-biggest holding next to consumer staples like Kraft Heinz (KHC) and Coca-Cola (KO) . Financials make up 32% of Berkshire's portfolio, while the consumer brands make up 37%.
Buffett's second-biggest holding, 504 million shares of Wells Fargo, makes up 16% of Berkshire's portfolio on its own. Long among his favorite investments, Buffett stuck with Wells Fargo even after the San Francisco lender's disastrous fake-accounts scandal went public last fall.
American Express (AXP) makes up 7% of Berkshire's holdings, at about 151 million shares, and Buffett has has held the company for years despite a steep decline last year when the card issuer lost a big account with Costco (COST) . (Wells Fargo, Kraft Heinz and Costco are part of TheStreet's Action Alerts PLUS portfolio.)
What does the billionaire investor see in financials and why is he so loyal to them? They hew to one of his long-term investment principles: Pick stocks of companies that are industry-leading brands and vital to other companies and the economy.
Banks like Wells Fargo and U.S. Bancorp may not be big in glitzy areas like trading, but they are huge in bread-and-butter lending to corporations big and small and among the biggest in the relatively mundane business of taking deposits and selling credit cards and home loans to consumers.
These are the very businesses that are poised to benefit from an improving economy and rising interest rates. Banks make money by paying very little for deposits and lending out that money at higher rates. Rising interest rates will widen that spread even more, as banks are usually slower to increase the rates they pay on interest-bearing deposit accounts than they are at jacking up loan rates.
Wells Fargo and U.S. Bancorp, a Minneapolis rival, are among the banking industry's strongest-performing companies, with returns on equity of 11.8% and 13.6%, respectively.
Another reason why bank stocks are attractive is they pay dividends, though not as they once did. As the economy improves, banks will be allowed to return more capital to shareholders so long as they are able to keep a healthy cushion against the next financial crisis. As of the end of November, when he last reported Berkshire holdings, Buffett's portfolio of 45 stocks included 33 that pay a dividend, and many of them more than 4%.
Berkshire holds a much smaller stake in another financial, Bank of New York (BK) , one of the dominant players in investment management, running the plumbing for the fund industry and reaping fee income.
Buffett has also shown a willingness to step up and buy financials when everyone is fleeing the sector, another one of his famous investment tenets -- buy when others are fearful.
In late 2008, as the financial sector reeled, he plunked $5 billion on deeply discounted shares of Goldman Sachs (GS) . A few years later, he did the same on a beaten-down Bank of America (BAC) . Both investments have reaped him billions of dollars in profit. He can't say the same for investment bankers, whom he has accused along with lawyers and other Wall Street types of selling companies at inflated values and reaping profits.
In his annual letter to Berkshire shareholders a couple of years ago, Buffett said of Wall Street: "Money shufflers don't come cheap."
At least sometimes their companies' stocks do.
I used the quantitative guru models that sit at the heart of my investing system to rank and score the financials in Buffett's portfolio. The four names below get the highest scores based on their financials and valuations. Investors looking to piggyback on Buffett's fondness for financials may want to start with these names first.
Score and Details
Bank of New York (BK)
81% based on strategy; looks for stocks trading at a reasonable price relative to earnings growth that also possess strong balance sheets.
Goldman Sachs (GS)
89% based on strategy; looks for companies with strong price momentum and EPS growth coupled with high return on equity and falling debt.
85% based on strategy; looks for growth stocks with persistent accelerating earnings and sales growth, reasonable valuations and low debt.
Wells Fargo (WFC)
100% based on large-cap value model that ranks stocks by value and dividends.