Warren Buffett: Why You Must Own Bank Stocks
Summary
TLDRIn this insightful discussion, the speaker evaluates the banking industry's profitability, emphasizing that banks can yield high returns on tangible equity if managed prudently. They compare bank stocks' historical price-to-earnings multiples to the S&P 500, noting a significant decline. The speaker advocates for a nuanced approach to valuing banks, considering their potential to generate cash flows over time rather than relying on a single metric like PE ratios. They also reflect on their own underestimation of the banking sector's performance, acknowledging that many banks have achieved impressive returns on equity despite the challenges of operating in a commodity-like industry.
Takeaways
- ๐ฆ The banking industry has historically earned high returns on tangible equity, which is a significant advantage over other industries.
- ๐ Banks that Warren Buffett and his partner Charlie Munger own have earned between 12% and 16% on tangible assets, indicating a robust business model.
- ๐น The long-term bond yield at 2% makes banking with a 12% return on assets a winning investment strategy over time.
- ๐ Bank stocks have been trading at a significant discount to the S&P 500, potentially due to market perception of risk or growth prospects.
- ๐ The relative PE multiples of bank stocks have declined over the decades, suggesting a change in market valuation methods or expectations.
- ๐๏ธ Not all banks are created equal; some have consistently earned low-risk returns on assets, while others have failed due to poor management.
- ๐ค Buffett acknowledges that he and Munger have underestimated the banking industry's ability to generate high returns on equity.
- ๐ผ The banking sector's success is not homogeneous, and it's crucial to evaluate each bank's management, risk profile, and growth potential individually.
- ๐ต The key to successful investing in banks or any business is to understand the cash it will generate over time and buy it at a discount to that value.
- ๐ซ Buffett warns against relying on a single metric like relative PE to make investment decisions; a more comprehensive analysis is necessary.
Q & A
What is the speaker's view on the profitability of the banking industry?
-The speaker views the banking industry as highly profitable, particularly when banks avoid making poor decisions on the asset side. They mention that banks can earn between 12% and 16% on tangible assets, which is a good business, especially when compared to long-term bonds at 2%.
How does the speaker compare the returns on equity of banks to other businesses?
-The speaker suggests that banks can achieve returns on equity that are well beyond what more glamorous businesses have earned in recent years. They imply that this is due to the nature of banking, which allows for high leverage and thus high returns on equity.
What is the speaker's opinion on the current valuation of bank stocks relative to the S&P 500?
-The speaker notes that bank stocks are currently trading at a significant discount to the S&P 500, possibly due to market perceptions of forward growth rates or risk. However, they also suggest that this could be an opportunity, as they believe banks are fundamentally strong businesses.
Why does the speaker believe that banks have been able to achieve high returns on equity despite dealing in a commodity like money?
-The speaker acknowledges that banks have been able to achieve high returns on equity by stretching equity further than was considered prudent in the past. They also suggest that banks have been able to employ more capital at the same high rate of return, which has contributed to their high profitability.
What does the speaker think about the use of a single metric, such as relative PE, to determine investment decisions?
-The speaker discourages relying on a single metric like relative PE to make investment decisions. Instead, they advocate for a more holistic approach that considers the business's ability to generate cash over the long term and the price at which it can be bought relative to that cash.
How does the speaker view the diversity within the banking industry?
-The speaker recognizes that banks are not a homogeneous group. They mention examples of banks that have been well-managed and have earned high returns on assets with low risk, as well as others that have been mismanaged and have failed.
What historical context does the speaker provide regarding the valuation of bank stocks?
-The speaker provides historical context by mentioning that in the 1940s, 1950s, and 1960s, bank stocks commonly traded at one times the S&P multiple, whereas now they might be half that, indicating a significant change in market perception.
What is the speaker's stance on the idea of using formulas or shortcuts for investing?
-The speaker is against the idea of using formulas or shortcuts for investing. They emphasize the importance of understanding the business, its economic characteristics, and the cash it can generate over time.
Why does the speaker believe that some banks have been able to earn over 20% on equity despite having a lot of goodwill?
-The speaker suggests that some banks have been able to earn over 20% on equity by stretching out equity and operating with more dollars per dollar of equity than was considered prudent in the past. They also acknowledge that they underestimated the potential for banks to achieve such high returns.
What does the speaker think about the future of bank stocks and their potential as investments?
-The speaker believes that bank stocks may continue to be good investments if they can maintain high returns on equity and if they can be bought at reasonable prices. They also mention that they have made mistakes in the past by underestimating the banking industry's potential.
Outlines
๐ฆ The Resilience and Profitability of Banking
The speaker begins by highlighting the rapid growth and profitability of the banking industry, emphasizing that banks have historically earned high returns on tangible equity, which is significantly higher than other industries. They mention that banks they own have earned between 12% and 16% on tangible assets, which is an impressive feat considering the low-interest rates of long-term bonds. The speaker refutes the notion that banks will decline to earning only 3-4% on tangible assets. They discuss the relative PE multiples of bank stocks compared to the S&P, noting that they are at historical lows. The speaker suggests that the market's perception of future growth rates or risk could be influencing these multiples. They also touch on the variability of bank performance, mentioning that while some banks have performed exceptionally well with low risk, others have failed due to poor management. The speaker advocates for a nuanced approach to evaluating banks rather than relying on a single metric like PE multiples.
๐ The Evolution and Opportunities in Banking
In the second paragraph, the speaker reflects on the evolution of the banking industry, noting that many banks have been mismanaged, leading to their downfall, but also creating opportunities for others. They mention the consolidation in the industry, with many banks disappearing over time, particularly in the late 80s and early 90s. The speaker advises against relying on a single metric like relative PE to make investment decisions, emphasizing the importance of understanding the business model and its ability to generate cash over the long term. They recount past experiences of evaluating and buying banks, highlighting the importance of low risk, cheap deposits, and reasonable prices. The speaker also acknowledges their own misjudgment in underestimating the banking industry's potential for high returns on equity, noting that many banks have earned over 20% on equity in recent years, which they find surprising given the commodity-like nature of money. They conclude by admitting their failure to adapt their views on banking despite these observations.
Mindmap
Keywords
๐กBanking
๐กTangible Equity
๐กReturns on Equity (ROE)
๐กAsset Side
๐กLong-term Bond
๐กRelative PE Multiples
๐กIncremental Returns on Incremental Equity
๐กBank Holding Company Act
๐กRisk
๐กGoodwill
๐กCommodity-like Characteristics
Highlights
Banking as a whole has earned rates that are well beyond tangible Equity.
Banks can earn between 12 to 16 percent on tangible assets, which is a good business model.
Banks are a fantastic business against the long-term bond at two percent.
The speaker doesn't expect banks to go down to earning only three or four percent on tangible assets.
Bank stocks versus the S&P seem to be at 30-35 to 50-year relative lows.
The appropriate multiple for a business relative to the S&P will depend on expected returns on equity.
Banks are not a homogeneous group; some have earned two percent on assets without taking real risk for decades.
The speaker owns a couple of banks and thinks they are somewhat different than other businesses.
People always want a formula for investing, but it doesn't work that way.
What matters is the cash a business will produce and buying it cheaper than that valuation.
The economic characteristics of a business determine how much cash it will generate over the long term.
The speaker has seen all kinds of banks ruined due to poor management.
There have been many banks that have disappeared over time.
The speaker and Charlie have failed to properly diagnose banking, underestimating the good results that would happen.
Banks have earned a lot more money on tangible Equity than expected.
Banks have stretched out equity much further than was the case 20 or 30 years ago.
A number of banks have earned very high Returns on Equity in recent years.
If banks can keep employing more Equity at the same high rate, it's also difficult to sustain.
Transcripts
you know the world compounds very fast
uh
you know banking as a whole
has earned rates that are
well beyond untangible Equity you know
well beyond I think
what much more glamorous businesses have
earned in in recent years well banking
is a good business if you don't do dumb
things on the asset side I mean
basically and uh
it's a business that uh
the banks we own earn between
uh
the commercial Banks earn between 12
percent
and 16 or so uh on tangent not tangible
assets that's a good business it's a
fantastic business against the long-term
Bond uh you know at two percent uh if
you have a choice between a two percent
instrument and twelve percent instrument
which was going to win over time so so
if you ask me whether I think uh
uh banks are going to go down where they
only earn three or four percent on
tangible assets I don't think that'll
happen uh I wanted to uh ask you to
comment on the relative PE multiples of
Bank stocks versus the s p they seem to
be at
you know 30 35 to 50 year relative lows
to the s p and I was wondering if that's
a result of the market a change in the
Market's perception of the forward
growth rates of uh Banks or uh if if the
market is perceived that there's a
change in Risk there
you asked by the performance of what
group compared to the s p uh Banks Banks
well
and and what was your assertion about
the performance historically well the
relative multiple of Bank stocks versus
the s p back in the 40s 40s 50s 60s they
commonly traded it say one times in s p
multiple and now they're maybe half that
one yeah Harry Keith used to have a lot
of figures on this and
I don't really think about uh about them
I mean the the appropriate multiple for
a business
relative to the s p will depend on what
you expect that business to achieve in
terms of Returns on on equity and
increment incremental Returns on
incremental equity
versus that s p i mean you've got if
you've got two dying types of businesses
and we'll say the s p earns Exxon equity
and and can deploy an additional amount
of capital at Y and then you compare
that with any other business and that's
how you determine which one is cheaper
uh
I would not characterize all banks as
the same I mean we have in this room
John four lines who runs the bank of
granite Granite North Carolina and
they've earned two percent on assets
without taking any real risk for decades
and it's a tremendous record and then
you have other banks that have been run
by
people that took them right into the
ground I mean that whether it was first
Pennsylvania going back 30 years ago I
think was John Bunning and they I mean
they they're not a they're not a
homogeneous
a group we own a couple of shock in a
couple of banks we own stock in m t that
has an exhibit downstairs today we own
stock in Wells Fargo
and
we think those institutions are somewhat
different than than other businesses so
I don't think there's a it goes back to
that earlier question people always want
a formula you know they I mean they go
to the intelligent investor and they
think you know somewhere they're going
to give me a little formula and then I
can plug this in and then I'll make lots
of money and it really doesn't work that
way what you're trying to do
is look at all the cash a business will
produce between now and Judgment Day
and discounted back at a rate that's
appropriate and then buy it a lot
cheaper than that and uh it whether the
money comes from a bank whether it comes
from an internet company or whether it
comes from a brick company
the money all spends the same now the
question is what are the economic
characteristics of the internet company
or the bank or the brick company that
tell you how much cash they're going to
generate over long periods in the future
and I would come to very different
answers
you know on M T Bank versus some other
bank so I wouldn't want to have a I
wouldn't want to have a single yard
sticker you know relative PE that I went
by uh I think that
banks have sold
uh a good many banks have sold at very
reasonable prices we bought all of a
bank in 1969 we bought a bank in
Rockford Illinois Charlie and I went and
looked at we must have looked at a half
a dozen banks at that
you know on a two or three year period
absolutely yeah we we trudged around and
and we found we found some very Oddball
banks that we liked uh and they were
characterized by uh by very little risk
on the asset side and very cheap money
on the deposit side
and even Charlie and I can understand
that
um and and low prices incidentally too
and then they passed the bank holding
company act in 1969 and and they killed
off our chances to do anything further
in buying all of banks so we look at
Banks we will own bank stocks from time
to time in the future we'll probably buy
stock in other Banks we've also seen all
kinds of banks ruined
I think it was
what was the fellow M.A Shapiro the uh
you came up with the statement he said
there are more Banks than bankers
and if you think about that a bit you'll
see what I mean uh
there have been a you know there have
been a lot of people
that have run banks in the very in
judicious manner but that's made for
opportunities for for other people the
uh there a lot of banks have disappeared
over time I mean up in Buffalo where
where Bob wilmer's runs m t uh
uh there were some other very
prestigious institutions that that went
right down the tubes and a lot of that
happened
in the early 90s or late 80s so I
I wouldn't look for a single metric
like relative PES to determine what how
to invest money at uh you really want to
look for things you understand
and where you think you can see out for
a good many years in a general way as to
the cash that can be generated from
business
and then if you can buy it at a cheap
enough price compared to that cash
it doesn't make any difference with the
name of it attached to the cache is
Charlie
yeah I think the questioner is
maybe even asking the wrong people that
question
I I would argue that Warren and I have
failed to properly diagnosed banking
I think we underestimated the general uh
good results that would happen because
we were so afraid of what non-bankers
might do when they were in charge of
banks
there are a number of banks that over
the last five or six years
untangible net worth the number of them
have a lot of Goodwill but untangible
net worth have earned over 20 on equity
you would think that would be difficult
for an industry to do
dealing in a commodity like money and of
course the bankers will argue it's not a
commodity but a lot of commodity-like
characteristics and you would think
those kind of returns
in a world of
six percent long-term interest rates and
much lower you'd think that would be
very hard to
well you you would have thought it
wouldn't have occurred you think it'd be
hard to sustain we've we've been wrong
in the sense that that
banks have earned a lot more money on
tangible Equity than Charlie and I would
have thought possible now I think to
some extent they've done it because
they've stretched out equity
much further than was the case 20 or 30
years ago I mean they they operate
with more dollars working
per dollar of equity than and then
people thought was prudent 30 or 40
years ago but however they've done it
they've earned a number of banks have
earned very high Returns on Equity uh in
recent years and if you earn high enough
Returns on equity and you can keep
employing
more of that Equity at the same rate
that's also difficult to do you know the
world compounds very fast uh you know
banking as a whole
has earned rates that are
well beyond untangible Equity you know
well beyond I think
what much more glamorous businesses have
earned in in recent years and Charlie
you have any further thoughts on that
all right
I say again we've
we didn't diagnose it as a
actually turned out
and uh even worse than that we haven't
changed
and even worse than that we won't
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