First, let’s simplify Warren Buffett’s investment philosophy.
1. Buffett likes to invest in companies with predictable earnings.
Bank of America, Citigroup and JPMorgan s’ earnings are much more predictable now than there were in 2008 – 2009. Despite the uncertainty due to the Dodd Franks, Basel and regulatory reforms, the core business of these banks are sound – that is the lending of money. While credit cards business might have uncertain outlooks, they account for 20% of the banks revenues. That is not a small sum for sure, but we can be certain that the earnings attributed to money lending is predictable. For a conservative estimate, we can just use these earnings and assume that earnings from the other division are zero or positive.
The 2013 conservative earnings estimates for the banks could be summarized below:
BAC: $20 billion or $2 EPS
C: $18 billion
JPM: $24 billion
In short, Buffett does not really like banks as their earnings are not as predictable as Coca Cola or Consumer products.
2. Buffett loves companies with monopoly power
Again, Buffett may not like this sector due to the lack of monopoly. The too-big to fail banks are not monopolists.
3. Buffett sees an investment based on its Annualized Compounded Returns
Using the banks, what Buffett would do is to project the share price of the banks in 2013 or what ever period he is interested in holding the banks for.
So in this case, if BAC has a projected EPS of $2, then its share price would most probably be $20 – $24 (10X – 12X PE)
So, let’s say the Future Value in 2013 is $20, and the Present Value (today’s price) is $11.5, then using simple calculation, the Annualized Compounded Return = (FV/PV)^(-1/2) – 1 = 30% annual compounded return.
That’s not bad at all.
If this is really 30% annualized return, Buffett will then compare it with other investments, if this yields the highest returns, he will buy this.
4. Buffett only likes good companies that will last forever
Banks will most probably last forever.
I will admit that this is too simplified. Buffett is more intense than this.
You be the Warren Buffett and comment on what other stuff Warren Buffett would have done to analyze an investment in Banking stocks.
17 comments:
Well I hope you and I are right because this has been my analogy from the beginning on financials. Long term things should straighten out and the out of favor financials - regionals and big four - will be back in favor. To further reinforce this no economy has come out of a recession w/o the financials assistance in the market.The only thing to worry about in BAC's case right now imo is the large share float. Time will tell if this was a Buffet move or not. I'm long for a decade.
NOTE: Good to see you back writing.
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