Saturday, December 6, 2008

The Warren Buffett Way: Chp 7 Part 5: Equity Marketable Securities

Wells Fargo

Wells Fargo is a large U.S. based bank. In October of 1990, Berkshire announced that they had purchased 10% of the bank's common shares at an average price of $57.88 per share. This purchase occurred during a time of fear in the market, especially towards banks like Wells Fargo that had exposure to West coast commercial and residential mortgages. The fear emanated from a widespread belief that a recession would cause significant losses in the real estate market.

Berkshire had acquired 98% of Illinois National Bank in 1969 and therefore Buffett was familiar with the banking business. Buffett believes that banks are commodity-like businesses, and therefore management is the most important factor for a banks success.

Buffett wrote that "banks don't have to be bad businesses, but often are". He feels that mistakes by bankers, specifically the issuing of bad loans, is the most likely cause of banks' problems. Buffett also commented that "you don't have to be number one in the banking industry, what is important is how you manage your assets, liabilities and costs". According to Bufett, if a bank is well managed, "it can earn 20% on equity, which is better than the average of what most other businesses earn."

One important operating measure of a bank is how they control their costs. Buffett and Munger felt that the Wells Fargo managers, Carl Reichardt and Paul Hazen were the best in the banking business. Carl Reichardt in particular, was legendary in his ability to control costs. Munger commented that Berkshire's investment in Wells Fargo represented a bet on the management team.

Despite Buffett's claim that he "underestimated the severity of the California recession and real estate troubles", Berskhire's investment in Wells Fargo common shares rose in value to $137 per share by the end of 1993.

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