Why Warren Buffett Should Buy Lloyds Banking Group PLC

When we think of legendary US investor Warren Buffett, we tend to think of his famous holdings in consumer goods giants: companies such as Coca-Cola, Procter & Gamble and Kraft Heinz.

However, it’s not a company from this area of the market that tops the holdings in Buffett’s Berkshire Hathaway investment portfolio. The number one slot is occupied by a bank, Wells Fargo. Buffett has increased his stake in Wells Fargo in recent years to the extent that he now owns 9.2% of the bank, a holding valued at $23bn.

Buffett only rarely invests outside of the US. His occasional dabbles in the FTSE 100 – Tesco, GlaxoSmithKline and Diageo – haven’t been hugely successful, and he currently holds no Footsie stocks.

However, I believe his fortunes would be bright if he bought into Lloyds Banking Group (LSE: LLOY) today. Indeed, I reckon if he was a UK-focused investor, Lloyds, which can be considered the UK’s equivalent of Wells Fargo, might well be in his sights.

Lloyds and Wells Fargo are both traditional banks, focused on providing straightforward services to individuals and businesses, and doing the simple things well to make decent profits for their shareholders. Both have the leading share of the mortgage market in their countries and take a conservative attitude to risk.

Managing through the crisis

The financial crisis was a bigger disaster for Lloyds than for its US counterpart. Lloyds’ ill-judged acquisition of HBOS, government bailout and suspension of dividends – together with other factors, such as PPI misselling compensation – have led to the Black Horse making a slower recovery than the Stagecoach.

However, Lloyds is getting there. The end of taxpayer ownership and PPI payments are in sight. Dividends have been resumed as Lloyds’ underlying business goes from strength-to-strength. The bank is doing the simple things well: efficiency ratios are improving, and profits, return on assets and return on equity are rising. The balance sheet grows ever more robust.

One valuation measure for Wells Fargo gives an indication of how the market might value Lloyds when the government exits its stake, compensation payments are consigned to history, and the underlying strength of the business shines through.

Wells Fargo trades on a price-to-book (P/B) ratio of 1.53, compared with Lloyds at 0.94. If Lloyds were to attract the same rating as its US cousin, its shares would be at 107p – a very healthy uplift on today’s 66p, and I think a fair indication of where we might hope the shares will be in a year or two.

The people at the top

Finally, returning to Warren Buffett and banks. The great man looks for personal integrity and long-term commitment from the managers of the businesses he invests in. He reckons these qualities are particularly important in the banking industry where the inherent leverage of the business magnifies managerial shortcomings.

Wells Fargo’s boss John Stumpf has been with the bank for 33 years. Lloyds’ chief executive Antonio Horta-Osorio has had only a five-year tenure to date, but had previously dedicated himself to Banco Santander (1993-2011). He enjoyed considerable success there but moved to Lloyds in the face of limited prospects of reaching the top of the Botin family-controlled Spanish bank.

In my view, Lloyds is a business with Buffett bank qualities, and appears well worth buying today, if you’re looking for a blue-chip bargain.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.