COF - The 3 Buffett-Backed Banks Nobody Is Talking About

2023-07-03 04:25:08 ET

Summary

• In this uncertain environment, investors want to know where to invest. It’s essential to keep in mind what stocks legendary investors are allocating funds to.
• "Past performance is no guarantee of future results" is the phrase of the day as we continue to stave off a recession amidst volatility.
• Consider these 3 bank stocks that have flown under the radar.

For many of us investors, Warren is an inspiration to how and why we invest. Even if we don't buy everything he does, there is a lesson to draw from each and every investment he aligns himself with. One of his favorite sectors to invest in has been banks, which he views as essential businesses that generate steady profits and dividends. In recent years, however, Buffett has been selling some of his bank stocks and getting more selective about which ones he keeps. So what is he buying, and which banks does he still like? In this article, we will reveal the top three Buffett-backed banks that you should buy and hold for the long term. Two of them are likely to surprise you, as one doesn't even appear in Berkshire's 13F, and the other is not a traditional bank but a digital disruptor in banking that is taking Latin America by storm.

1. East West Bancorp

I won't leave you in suspense until the end of the article. The surprise is East West Bancorp ( EWBC ) which is a rare combination of growth and profitability in the banking sector. The bank serves the Asian-American community and facilitates cross-border trade and investment between the U.S. and China, which gives it a unique niche and a loyal customer base. Amidst the turmoil of the Silicon Valley Bank collapse, regionals as a whole declined, and with them, East West Bancorp took a hit. This isn't just any regional bank; however, it has the most incredible growth prospects I've ever seen in a regional bank. I covered those prospects very recently here .

By now, I hopefully have you wondering what could make this bank so exciting. The short answer is its customers.

Asian Americans are the fastest growing demographic in the country, growing at 3x the national average. East West is dominant amongst this demographic. It caters to Asian Americans with a website that quickly translates Asian languages, employees of Asian descent, and operations in Asia.

These features make it a go-to for their target demographic. Therein lies the moat, a customer base that is unlikely to find this level of resources at any other financial institution.

This isn't the only feature that makes this a strong demographic to have locked down in SoCal.

As I asserted in my previous article, "This demographic is also the single most affluent in the country. The median household income for Asian Americans was $98,174 in 2019, compared to $68,703 for the total U.S. population. It should go without saying, but this bodes well for the bank's deposits."

EWBC has a net interest margin ((NIM)) of 4.24% which is nearly double the industry average of 2.97%, and we can surmise that the bank has a significant spread between its interest income and interest expense. This is a reflection of EWBC's low-cost deposits from its demographics, who generally have higher savings rates as well as lower default rates compared to other groups. This also reflects EWBC's tendency to lend at higher rates in more niche segments like entertainment, technology, and commercial real estate. Its customers are happy to pay these higher rates for the quality of customer service, and tailored resources they receive in turn.

The bank has over $64 billion in total assets and over $55 billion in deposits, making it the largest publicly traded bank in Southern California. As I covered in my previous EWBC article, the bank's profitability is above average in every significant metric, such as return on equity, return on assets, net interest margin, and efficiency ratio. The figures have not meaningfully changed since I first analyzed them.

Despite its impressive fundamentals and growth potential, the bank is trading at absurdly low valuation multiples, with a price-earnings ratio of 6, a price-book ratio of 1.1, and a discount to the fair value of about 150% utilizing an excess returns model.

You didn't see this in Buffett 13F filing. So it is entirely reasonable at this point to be questioning how EWBC belongs on this list. Many investors and analysts have never even heard of EWBC, I'd contend this, and its lack of coverage is another reason it trades at such a discount. Nevertheless, this stock has meaningful ties to Buffett through his Asian counterpart.

A man Charlie Munger and Buffett called the 'Warren Buffett of China." his name is Li Lu. He owns and manages Himalaya Capital, and his most recent 13f indicates he has taken a significant holding in EWBC. Li bought up over 2.3 million shares. This investment, in my eyes, is more exciting than your average Buffett Purchase.

Warren said it best, "The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good big ideas." The fact of the matter is that Li Lu is not beholden to the size Berkshire is. He can make investments such as this that Warren may otherwise be unable to make. His returns are an astounding 30% annually, and it may be a good idea to pay attention when he initiates a position.

2. StoneCo

StoneCo ( STNE ) is a Brazilian fintech company that provides a cloud-based platform for merchants to conduct electronic commerce across in-store, online, and mobile channels. The company charges fees for its services, which include transaction payment processing, prepayment financing, subscription, and equipment rentals. StoneCo targets small- and medium-sized businesses, which account for most of the economic activity in Brazil.

I wrote an in-depth article on Seeking Alpha back in May about why STNE was poised for growth. The story is simple, really, In short, StoneCo offers a superior digital payments solution service in one of the world's fastest-growing economies that also happens to be rapidly digitalizing.

Let's take a look at the numbers, shall we? First up is digitalization trends in Brazil, where it operates. We will use PIX's revenue figures, which is the transfer platform launched by Brazil's Central Bank, to represent the inflows in digitalization. StoneCo is a participant in the PIX platform, which allows users to transfer funds between banks and other platforms quickly and is the foremost service of its kind.

As you can see, revenues are conservatively projected to increase YOY and grow quite significantly as access to technology is expected to increase. This secular tailwind is likely to drive growth in this sector and produces continued success in StoneCo's already impressive profitability and margin. Let's look at that growth as I explored in my article "StoneCo has grown rapidly since its inception, reaching over 2.6 million active clients as of Q4 2022 , up 211,000 a year prior. The company's total payment volume (TPV) increased by 22% year-over-year to $81 billion, while its total revenue grew by 63% year-over-year to $9.59 Billion and its adjusted net income hit $525.5 million which is over 6x higher than 2021."

Year after year, StoneCo experiences dramatic revenue growth, client growth, and TPV increase. yet for years, the stock remained stagnant or declined but why? The short answer is political instability. Brazil is in a lot of political turmoil, I am not a political analyst, but I can use my resources. There are a number of sources I could point to that suggest that the political uncertainties are unlikely to affect digital payment solution providers, but I believe the best resource is Berkshire. See, while you may not have many analysts here who are truly qualified to speak on political climates, Berkshire certainly does. When they determine a climate to be risky, they have no qualms about closing a position as they did with Taiwan Semiconductors. However, Buffett has held StoneCo since 2018, even when it climbed as high as $92 dollars per share. To me, this suggests that he or one of his close associates has no such fear in this climate.

I also shared a comparison to its peers previously that remains relevant.

Either STNE outperforms its competition or remains above average in any given relevant growth or profitability metric. That is why they stand out. However, Buffett is never one to settle only for growth, he looks for growth and value. STNE certainly has both. Just take a look at a comparison to its peers.

Source: Author, Seeking Alpha

Finally, the stock is trading at a rather meaningful discount to just about all of its historical averages .

Berkshire Hathaway owns about 3.4% of StoneCo's outstanding shares. Buffett first acquired shares of StoneCo in the fourth quarter of 2018, just after its IPO, at an average estimated price of $24.04 per share. STNE reached a peak in 2021, trading at $91. Buffett did not divest.

3. Capital One Financial

Capital One Financial ( COF ) is a truly rare bird in that not only did we see it appear in Berkshire's 13F but also In Michael Burry's Scion Asset Management 13F. It is exceptionally uncommon that we see the two enter into a position together despite Michael describing himself as a product of Buffett's work.

I am under no illusions about the nature of this investment. Make no mistake. This is a recession play. Just take a look at the chart below.

Even in the financial collapse of 08' credit card companies continued to make money. That's right, "risky" credit cards were paid off while the "safe" mortgage lending market collapsed, and the banks along with it. The underlying business model here is totally resilient to economic downturns and slowdowns. That's our second point of interest.

The third is, as Michael Burry calls it, "Sheer Outrageous Value."

You have the chance to own a bank trading at less than the value of the assets on its books with 100 million accounts and a catchphrase as memorable as "What's in your wallet?". Compared with its industry in credit services, it is very cheap, on all the metrics of interest. While you wait for your price appreciation, you can enjoy a very safe 2.19% dividend.

The Takeaway

Buffett, Lu, and Burry have invested in these companies for reasons that, in my opinion, are not hard to ascertain. These businesses make money, they are growing, and they are discounted. While so many retail investors scramble to find the next Google and Amazon, these super investors serve to remind us that sometimes investments are just that simple.

For further details see: