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 Barclays (LSE: BARC) (NYSE: HBC.US) is a wonderful company, and whether its shares are trading at a fair price.
A wonderful company?
Barclays has a ‘universal banking’ business model, with investment banking representing a substantial part of the group’s operations. Indeed, Barclays’ bold acquisition of Lehman Brothers’ US business when that bank collapsed at the height of the financial crisis propelled Barclays into the top tier of global investment banks.
Buffett has backed investment banks before — but as crisis plays on extremely favourable terms. Most notably, he injected $5bn into Goldman Sachs during the financial meltdown of 2008, cutting a deal that gave him a whopping 10% yield on preferred stock, and warrants on the common stock at a discount to what was an already-trashed share price.
We have to look elsewhere for Buffett’s idea of a wonderful bank; that’s to say a bank in which he’s been prepared to make a substantial long-term investment in the ordinary shares. Wells Fargo is not only a longstanding favourite of Buffett’s, but also is his biggest holding with a current valuation of $20bn.
Wells Fargo is largely traditional lender, but has moved into investment banking in a modest way in recent years. However, the focus is on lower risk plain-vanilla products, such as US debt and equity underwriting, and insiders say the division is unlikely ever to account for more than 10% of the company’s total revenue or profit.
In contrast, Barclays’ investment bank was responsible for half of group revenue and profit last year. However, there is a big plus for Barclays in that it has another significant operation in what Buffett sees as a very attractive business segment.
Buffett has a $12bn stake in American Express, and also holds shares in Visa and Mastercard. Barclays’ Barclaycard has been a strong and innovative brand ever since its launch in 1966. The Barclaycard division contributed 17% to Barclays’ total income last year, and had the highest return on equity (22%) of all the group’s businesses. Buffett loves a high return on equity.
A fair price?
I don’t think Barclays quite makes the grade as a Buffett ‘wonderful company’, but it does have some qualities the master investor likes. Buffett has been happy to pay 1.5 times book value for Wells Fargo’s shares, while Barclays is trading at a discount to book. On balance, I’d say Barclays is a fair company at a wonderful price, as opposed to a wonderful company at a fair price.
