The Warren Buffett Bear Case For Royal Bank Of Scotland Group plc

Many investors who focus on a low price-to-earnings (P/E) ratio and high dividend yield in their search for value will have a hard time swallowing the maxim legendary investor Warren Buffett lives by: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

Today, I’m considering whether FTSE 100 bank Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) is a wonderful company, and whether its shares are trading at a fair price.

Buffett and banks

Buffett has said: “The banking business is no favorite of ours … mistakes that involve only a small portion of assets can destroy a major portion of equity”. He has bemoaned “the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so”.

Buffett wasn’t talking about the recent financial crisis. The above words come from a 1990 letter to the shareholders of his Berkshire Hathaway investment company. At the time, Buffett had just taken his stake in US bank Wells Fargo to 10%.

Buffett has continued to back Wells Fargo, buying more shares in recent years to the extent that the bank is now Berkshire’s biggest holding, currently valued at around $20bn.

Exceptional management

Wells Fargo has a number of attractive characteristics, but the overwhelming strength in Buffett’s eyes is exceptional management.

Back in 1990, Buffett said: “We think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen”. Both joined Wells Fargo in 1970, and were the kind of committed managers, passionate about their company, that Buffett generally prefers to invest in.

Current boss John Stumpf is cast in the same mould, a 31-year Wells Fargo veteran.

Buffett has neatly summed up what he expects from his bank executives: “Stick with what they understand and let their abilities, not their egos, determine what they attempt”.

Royal Bank of Scotland

Speaking of egos brings me to disgraced former Royal Bank of Scotland (RBS) boss Sir Fred Goodwin, whose vanity and self-aggrandisement brought the bank to its knees during the financial crisis.

As well as Goodwin, all RBS’s directors of the era — executive and non-executive — have been cleared out of the boardroom. As such, the current men at the top haven’t been in place for long; in fact, chief executive Ross McEwan has taken up his duties just this week!

Furthermore, McEwan — and finance director Nathan Bostock — have peripatetic histories, both moving around companies to further their careers.

A fair price?

I conclude that RBS is no Wells Fargo. The short tenures of the current executives, who also have no long record of commitment to the bank, fail to meet Buffett’s paramount consideration of exceptional management. A fair price simply doesn’t come into it.

Buffett rarely invests outside his home US market, but has backed one well-known UK business big-time. The multi-billionaire owns over 5% of this company's shares.

If you'd like to learn all about Buffett's big UK bet, you may wish to read this exclusive in-depth report. The report is 100% free and can be in your inbox in seconds - simply click here.

G A Chester does not own any shares mentioned in this article.