Investor Warren Buffett (Trades, Portfolio) endlessly encourages investors to stick to their "circle of competence." At his Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) annual conference in May, he said that he naturally took to the insurance business, which would become the core of his business empire.
"I knew when I met [Geico executive] Lorimer Davidson in January of 1951, I could get insurance. I mean, what he said made so much sense to me in the three or four hours I spent with him on that Saturday. So, I dug into it and I could understand it. My mind worked well in that respect," Buffett said.
Financials in general became one of Buffett's fortes. In Berkshire Hathaway's portfolio, 46.19% of shares belong to companies in the financial services sector. That is nearly double the second-largest sector represented, technology, at 25.71%.
In the past year, the SPDR Financial Select Sector ETF fell 2.47%, while the S&P 500 index advanced 2.05% as the Federal Reserve hiked interest rates for the first time in years. Banks' net interest income tends to grow when interest rates rise. This week, Fed watchers and analysts have disagreed about whether its gathering of experts for a meeting in Chicago will result in an interest rate cut at its next meeting on June 18 to 19.
On Tuesday, Federal Reserve Chairman Jerome Powell said the central bank may take steps to sustain the economy's expansion. In a speech in Chicago, he commented on the trade war with China and the possibility of new tariffs on goods from Mexico.
"We do not know how or when these issues will be resolved," he said in opening remarks. "We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective."
But Buffett has been buying and holding financial stocks throughout the varying economic conditions of recent decades. His three largest financial positions he started during times of financial setback. As of first quarter-end, his favorite were: Bank of America Corp. (BAC), Wells Fargo & Co. (WFC) and American Express Co. (AXP).
Bank of America Corp. (BAC)
For years, Bank of America was one of Berkshire Hathaway's "shadow" top-10 holdings. That is because he invested in the bank via warrants in 2011 when it hit financial trouble. For $5 billion, Buffett got 700 million shares of its common stock with an exercise price of $7.14.
When he exercised the warrants in August 2017, the bank's share price closed at $23.58, giving him a profit of roughly $11.5 billion. Bank of America stock has risen in value even more since then. It traded Thursday around $27.88, up about 12% for the year to date. That makes the value of Buffett's original holding of Bank of America around $19.5 billion, for a profit of $14.5 billion.
He also bought additional shares more recently. In the third quarter of 2018, he increased his holding by 29.2% when the share price averaged around $30. He added another 2.16% in the fourth quarter when the price averaged $27.
At 12.39% of his portfolio, Buffett's 896,167,600 shares represent Berkshire's second-largest holding.
In the first quarter, Bank of America's revenue held relatively flat at $23 billion compared to $23.1 billion in the same quarter of 2018. Net income rose to $7.3 billion from $6.9 billion in the prior-year quarter due to strong operating leverage. Average deposits also grew 5% to $63 billion, while loans rose 5% to $292 billion.
Bank of America has a price-earnings ratio of 10.37 and price-sales ratio of 3.08. Its price-book ratio of 1.12 is higher than 54.15% of companies in the global banks industry.
Wells Fargo & Co. (WFC)
Buffett has called Wells Fargo a "wonderful business" in the past, but said at his shareholder meeting in May that it "should be checked out on everything they do," after it was found in 2016 to have generated millions of fake accounts. Despite its transgressions, Berkshire's co-Chairman Charlie Munger said at the meeting that "we would cheerfully buy more" if the government lifted its ban on shareholders owning more than 10% of a bank.
Berkshire owned 9.12% of Wells' shares at first quarter-end, after chiseling down the holding 3.98% to comply with Federal regulations. In more than half of quarters from the first of 2009, when the price averaged $16, through the fourth of 2015, when the price averaged $54, he was buying more shares of the company.
Buffett started the position in 1989, buying a 10% stake for $290 million. At the time, it traded under five times after-tax earnings and less than three times pre-tax earnings. In his letter from 1990, he told shareholders the purchases were "helped by a chaotic market in bank stocks" due to "foolish loan decisions" or "once well-regarded banks."
Management was one of the bank's biggest draws for Buffett, who criticized other banks' high assets compared to equity.
"Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices," he said. "With Wells Fargo, we think we have obtained the best managers in the business."
Buffett's holding has increased in value to $19.8 billion, making it his third-largest portfolio position.
The bank's share price has declined 2.3% year to date and 17.6% in the past year, closing Thursday at $45.92. In the first quarter, it reported a decline in revenue to $21.6 billion from $21.9 billion a year earlier. Net income rose to $5.9 billion from $5.1 billion. Its average deposits decreased 3% to $1.3 billion, while average loans fell by $876 million to $950.1 billion.
Wells Fargo has a price-earnings ratio of 10.14, price-book ratio of 1.12 and price-sales ratio of 2.58. Each is near its five-year low.
American Express Co. (AXP)
Buffett addressed the origin of credit card payments company American Express as recently as his shareholder meeting in the spring, saying "I'm glad I own 18% of it."
He started the position by investing $300 million into the company when it had financial trouble in 1991. In 1994, he increased Berkshire's position to nearly 10%, according to The New York Times. As of the end of the first quarter of 2019, he owned 151,610,700 shares of American Express, valued at $16.6 billion, and has not sold any shares in at least the past decade.
Despite increased competition from other companies like Apple (AAPL) issuing credit cards, Buffett saw American Express as continuing to have room to grow globally.
"If you look at credit card usage, there are a lot of different things motivating different people to use different various types of payment systems," Buffett said at his meeting. "And there's a lot of them that are growing. There are some of them that are marginal. And American Express is an extraordinary operation."
In the first quarter, American Express reported a 7% year-over-year rise in total revenues net iof interest expense to $10.36 billion, largely due to higher card member spending, loan volumes and fee income. Net income declined 5% to $1.55 billion, including a charge for legal fees. It also affirmed its guidance for the full year.
American Express is Berkshire's fifth-largest holding. With its price up 23.5% year to date, the stock closed at $119.43 per share Thursday. It has a price-earnings ratio of 15.23, price-book ratio of 4.52 and price-sales ratio near a three-year high at 3.45.