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Buffett Likes the Banks, Why You Should Too

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As the major indexes flirt with new all-time highs, investors understandably have been wondering how far this bull market has to run. While prognostications abound about what “inning” we are in – to use the popular baseball analogy – the answer is that no one really knows, even though all signs point toward continued economic expansion and the rising share values that accompany it.

The history of the markets with regard to the length of bull markets is fairly meaningless. Domestic and world conditions have been significantly different through each of the bull and bear markets that have come before and direct comparisons to our current situation are a guess at best.

Learn from the Best

For a look at where the markets are headed, it certainly does make sense to look at what moves experienced investors are making, and there’s no one more experienced than Warren Buffet. Arguably the most successful investor of all time, Buffett has succeeded through bull and bear markets and everything in between for over 50 years.

Though generally known as a “value” investor, it might be more accurate to describe Buffett as an opportunity investor. He has made outsized profits in high flying tech companies like Apple (AAPL), which he started buying in 2016, well before it’s incredible march past $1T in market cap, as well as beleaguered financial firms, buying a stake in Goldman Sachs (GS) at the height of the financial crisis in a prescient bet that a rebound was on the horizon.

In a positive sign for the markets, Buffett’s Berkshire Hathaway has continued to add to its holdings through the second quarter of 2018, most notably buying more shares of Apple as well as two of the best managed banks in the U.S. – US Bancorp (USB - Free Report) and Bank of New York Mellon (BK - Free Report) . Bank stocks have underperformed the broad markets in 2018 even with earnings growing and a favorable economic climate, creating a Buffet-style opportunity to add exposure at attractive prices.

A rising interest rate environment should boost performance at banks - increasing the net interest margin banks earn on the spread between deposits and loans.

Disciplined Performance

US Bancorp survived the financial crisis without a single negative quarter – even as large competitors faltered – by effectively managing the quality of its assets and avoiding significant write-downs. Bank of New York Mellon was named the master custodian of the Troubled Asset Relief Program (TARP) and was one of one three institutions found in the initial round of stress-test to be likely to retain profitability in a major downturn.

That same discipline continues today.

Though both BK and USB have seen earnings estimates revised upward lately and both are a Zacks Rank #2 (BUY), P/E ratio is not as helpful for the analysis of banks as the specific measures of Return on Equity and Return on Assets and Return on Capital.

Both Banks compare favorably to the industry as whole in these measures of how well they use their assets to generate income:

 

                                BK         USB        Industry

ROE                       11.4%      14.7%          9.2%

ROA                       1.2%         1.4%          0.6%

ROC                       6.0%         7.7%          3.2%

 

Healthy Yield

Dividends are an often overlooked component of investing success, especially in bull markets. During periods when share prices gain double digits per year, it can be easy to ignore the impact cash dividends have on total return, but in the long run they can significantly increase investing results. In sluggish, sideways markets, owning companies with the cash flow to pay dividends can be the difference between some positive return and no return at all.

With huge stakes in the companies he invests in, you can bet Warren Buffett doesn’t ignore the impact of dividends and neither should the individual investor.

Patience is not Boring

Though most of the attention lately has been paid to the FAANG stocks, crypto-currency names and most recently, companies in the burgeoning marijuana industry, a well-rounded long-term portfolio should have a healthy portion of well-managed U.S. companies with a history of strong performance in good and bad economic times and that reward investors with consistent dividends.

If you don’t know where to find them, just take a look at what Warren Buffet is doing.

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The Bank of New York Mellon Corporation (BK) - free report >>

U.S. Bancorp (USB) - free report >>