As of Berkshire Hathaway's (BRK.A -0.28%) latest 13-F SEC filing, the company holds a massive stake in Wells Fargo (WFC -0.56%), totaling more than 463 million shares, or more than 9% of the total. In fact, Wells Fargo is currently Berkshire's single largest common stock investment by a pretty big margin.
Wells Fargo is definitely one of the leaders in the banking sector, with the top market share in mortgage lending and auto lending, and incredible growth in other areas of the business. And the company continues to produce impressive growth, as we saw in Wells' latest quarterly earnings report.
However, the company's shares are "expensive" by banking standards, trading for a much higher price-to-book multiple than the rest of the "big four" banks. So, why has Warren Buffett called Wells Fargo his favorite bank, and is it still a good time to buy in?
What Buffett looks for
Buffett likes to invest in companies with a "wide moat."
Essentially, this means that the company has a distinct competitive advantage that will keep it a market leader for years to come. For example, some companies own lots of valuable patents (like Pfizer) and some companies have become so big they can use economies of scale to undercut the competition and still be profitable (like Wal-Mart).
And, Buffett likes companies in industries that will be around in another 100 years. People will always need food, houses, and safe places to put their money, so it's no surprise that companies in these industries make up a large percentage of Berkshire's portfolio.
On the other hand, will people still need tablet computers or smartphones in 100 years? Maybe, but maybe not.
Why Wells Fargo has a "wide moat"
First of all, Wells Fargo is not like other banks. If you look at the company's profile, it looks a lot more like an old-time savings and loan than one of the biggest banks in the world. Whereas the revenue of the other big banks is highly dependent on things like trading and investment banking, Wells Fargo focuses on core banking business like lending.
And, it has become the best at what it does. Wells Fargo became the number one mortgage lender in the U.S. some time ago, and recently overtook Ally Financial for the top auto lending spot. In fact, the nearly 60% of Wells Fargo's profits come from traditional consumer and business banking activities.
This is an excellent example of the "100-year idea". People will always need safe places to keep their money, and access to borrowing money for their houses, cars, and other big purchases. So, Wells Fargo's revenue stream is a more constant, reliable one than many of its peers.
Even though it is the largest U.S. bank (by market cap), Wells Fargo is still doing an excellent job of growing. The bank has grown its consumer checking customer base by 5% over the past year, and grew many parts of its lending business at double-digit annual percentage rates, such as auto lending and credit cards.
However, one of the biggest reasons Wells Fargo is attractive is its ability to maximize revenue by cross-selling products to existing customers, an area in which the bank has been recognized as a leader for some time now. The average household that banks with Wells Fargo has more than six different products with the bank, including deposit accounts, brokerage accounts, loans, and insurance products.
And, this number is growing. Wells Fargo aims to get this average up to eight products for each of its banking households in the short-term, and ultimately wants to become a one-stop shop for all of its customers' banking needs.
Expensive and cheap at the same time?
As I mentioned earlier, Wells Fargo trades for a much higher valuation than the other "big four" U.S. banks, but for a very good reason.
Simply put, Wells Fargo's asset quality and safety are deserving of a premium valuation. The bank has a very low charge-off rate, capital levels are strong, and exposure to risky assets and businesses (like emerging markets) is kept at a minimum.
Still, shares are trading at a relative low price-to-tangible book ratio on a historic basis, and shares are actually cheaper now than they were before the company reported its earnings, thanks to the recent market sell-off.
So, Wells Fargo costs more, but can be well worth it. The bank is a leader in its core businesses, and is still producing excellent growth. If you want some exposure to the banking sector in your portfolio, it's tough to find a company that has the same combination of stability, strength, and growth potential as Wells Fargo, and that's exactly why Warren Buffett has put so much of his own money in it.
