Warren Buffett on Wells Fargo

Fortune: How is Wells Fargo unique?

Warren Buffett: It's sort of hard to imagine a business that large being unique. You'd think they'd need to be like any other bank by the time they got to that size. Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, "Everybody else is doing it, why shouldn't I?"

What about all the smart analysts who think no big bank can survive in its present form, including Wells Fargo?

Almost 20 years ago they were saying the same thing. In the end banking is a very good business unless you do dumb things. You get your money extraordinarily cheap and you don't have to do dumb things. But periodically banks do it, and they do it as a flock, like international loans in the 80s. You don't have to be a rocket scientist when your raw material cost is less than 1-1/2%. So I know that you can have a model that works fine and Wells has come closer to doing that right than any other big bank by some margin. They get their money cheaper than anybody else. We're the low-cost producer at Geico in auto insurance among big companies. And when you're the low-cost producer - whether it's copper, or in banking - it's huge.

Then on top of that, they're smart on the asset size. They stayed out of most of the big trouble areas. Now, even if you're getting 20% down payments on houses, if the other guy did enough dumb things, the house prices can fall to where you get hurt some. But they were not out there doing option ARMs and all these crazy things. They're going to have plenty of credit losses. But they will have, after a couple of quarters of getting Wachovia the way want it, $40 billion of pre-provision income.

And they do not have all kinds of time bombs around. Wells will lose some money. There's no question about that. And they'll lose more than the normal amount of money. Now, if they were getting their money at a percentage point higher, that would be $10 billion of difference there. But they've got the secret to both growth, low-cost deposits and a lot of ancillary income coming in from their customer base.

So what is your metric for valuing a bank?

It's earnings on assets, as long as they're being achieved in a conservative way. But you can't say earnings on assets, because you'll get some guy who's taking all kinds of risks and will look terrific for a while. And you can have off-balance sheet stuff that contributes to earnings but doesn't show up in the assets denominator. So it has to be an intelligent view of the quality of the earnings on assets as well as the quantity of the earnings on assets. But if you're doing it in a sound way, that's what I look at.

Link to the Article

Valuing Equities in an Economic Crisis or How I Learned to Stop Worrying about the Economy and Love the Stock Market

Having spent the last decade decrying stocks as overvalued despite what has generally been an extremely benign economic backdrop, some of our clients are a bit bemused to find us more bullish than many of their other managers today. After all, isn’t this the worst economic crisis since the Great Depression? If we could hate stocks when times were great, shouldn’t we hate them even more when the world seems to be going down the drain? But given our basic set of beliefs – mean reversion happens, the economy is driven by the skills of the workforce and the physical and intellectual capital of companies, equities are long duration assets – both stances are completely consistent. To us, the true value of the stock market changes very slowly and smoothly. It is the myopia of investors that causes market prices to vary so wildly.

In their recent panic, investors have driven U.S. equity valuations down below fair value for the first time in well over a decade. This is not particularly surprising given the economic environment, but we should not confuse a predictable event with a justifiable one. Given that we are in an economic crisis, investors were apt to overreact to the bad news and drive the market down, but we believe that this is not warranted given the underlying fundamentals of the market.

John Templeton’s famous line, “The four most dangerous words in investing are ‘This time it’s different,’” is usually taken to apply to New Era bull markets. But it is just as applicable in a bear market. Because the economy is a mean reverting system, things have never been as good as they appeared in the booms, and have never yet been as bad as they appeared in the busts. We believe that this time will not be different, and history, at least, is on our side.

Given our assumptions, fair value for the S&P 500 is around 900. Long-term investors in stocks should therefore do well if they invest at current levels. An investor who correctly guesses that the market will bottom at 600 and waits until then to invest will do even better. But that investor is taking the risk that investors overreact less to this crisis than they have in previous crises and, in waiting for the perfect entry point, may miss the best opportunity to buy equities in over 20 years.

Link to the Paper

Warren Buffett takes charge

Buffett, who is 78, was intrigued by Munger's description of the entrepreneur behind BYD, a man named Wang Chuan-Fu, whom he had met through a mutual friend. "This guy," Munger tells Fortune, "is a combination of Thomas Edison and Jack Welch - something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I have never seen anything like it."

In acquiring a stake in BYD, Buffett broke a couple of his own rules. "I don't know a thing about cellphones or batteries," he admits. "And I don't know how cars work." But, he adds, "Charlie Munger and Dave Sokol are smart guys, and they do understand it. And there's no question that what's been accomplished since 1995 at BYD is extraordinary."

"How did BYD get so far ahead?" Warren Buffett asked Wang, speaking through a translator. "Our company is built on technological know-how," Wang answered. Wary as always of a technology play, Buffett asked how BYD would sustain its lead. "We'll never, never rest," Wang replied.

Full Article

The News Which Never Made the Front Pages

March was a weird month. Whilst our American friends submerged themselves in a rather ludicrous and altogether unproductive debate on who is to blame for the fact that the ‘crooks’ at AIG nicked a bonus for themselves, on this side of the Atlantic, Gordon Brown, whose political career is now on life support following a number of embarrassing hiccups, has dedicated the last few weeks to making sure that the G20 summit will go down in history as a resounding success. Even the banks, which continue to show little appetite for lending, have found that the last month offered some unexpected relief, as the preparations for the G20 meeting forced Brown and his lieutenants to focus on other matters.

Now, these distractions are not necessarily bad news because it means that news which would normally hit the front pages won’t always get the attention it deserves which, in the world of finance, can only be regarded as an opportunity. And that is precisely what this month’s Absolute Return Letter is about – events which have happened over the past few weeks which didn’t get the attention they deserved.

Link to the Letter

Fireside Chat -- Martin Capital Management

As value investors, our perspective is more patient and measured, no doubt out of respect for the difference in the character of bull and bear markets. The big bull markets typically begin deep in the hole and then spend years climbing what market commentators have called a “wall of worry,” as memories of what created the hole in the first place slowly fade. The emotional forces motivating investor behavior are comparatively mild in generally rising markets, unless or until the bull phase reaches the stage where rising prices themselves become the primary exciting force propelling further advances. At that point prices effectively detach themselves from the traditional tethers to value.

We can’t call markets, but we can observe human behavior. We suspect that this secular bear market will end with a whimper and not a bang. Futile attempts to pinpoint some elusive bottom will eventually give way to despair. When buying bargains on the sale rack yields nothing but disappointment, when patience wears thin, and when hope is finally abandoned, opportunity
clothed in black will be abundant. While nobody knows to what levels the popular indices might sink—and when—like the flipside of the bull market just passed, one need only be generally right to sleep peacefully at night and earn low-risk, wealth-building rates of return.

Direct Link