BAC Stock: Is Warren Buffett Wrong About Bank of America Corp?

BAC StockWarren Buffett and BAC Stock

Warren Buffett’s love affair of Bank of America Corp (NYSE:BAC) is well known, but most investors don’t see what has the “Oracle of Omaha” so enamored. In fact, many think that owning BAC stock was the biggest mistake of Buffett’s career.

How wrong they are. Not only is it shockingly arrogant to think you can outwit the great capital allocator of our time, but it’s also obvious that Bank of America has some strengths. You may not be incredibly fond of financials, but that doesn’t mean they make for terrible investments.

I know a lot of investors who got burned by bank stocks in the financial crisis. It was a hard time to figure out which banks were safe and which were on the brink of insolvency.

But there was one thing you could count on: the U.S. government was not going to let the biggest banks in America go bankrupt. It simply was not an acceptable outcome for regulators whose main job was to safeguard the economy. The collapse of a major commercial bank would have been disastrous to their credibility and to the health of the global financial system.

That being said, banks faced heightened scrutiny in the years that followed. They were hit with hefty fines and tougher regulations, causing many investors to think their era of growth was all but over. But Warren Buffett is drawn to that kind of pessimism like a moth to a flame—that’s where he eats his breakfast.

Buffett realized that bank stocks as a whole were down, but some were safer than others.

He understood a fundamental truth about how deeply some banks are embedded in American life. Firms like Bank of America have branches and ATMs across the country, making them more insulated from regulatory risk than plain old investment banks.

They are interwoven into the fabric of the financial system, which is why they could afford to buy out Merrill Lynch and Countrywide Financial. In any case, it’s been several years since Warren Buffett bought BAC stock. So the returns speak for themselves.

As part of his deal with BofA, the Oracle of Omaha purchased $5.0 billion in preferred shares with a six percent annual yield. He also had the wisdom to buy another $5.0 billion worth of warrants. According to that contract, Buffett can buy 700 million shares of BAC stock any time before September 2021. (Source: “To the Shareholders of Berkshire Hathaway Inc.,” Berkshire Hathaway, February 27, 2016.)

Those warrants are currently worth $11.8 billion. He’s more than doubled his money in just a handful years and he won’t stop there either. Buffett has previously stated he wants to hold onto the warrants until they’re close to their expiry date. Do you know why?

It’s because he thinks they’ll be worth significantly more than they are right now. But don’t just trust me; read Buffett’s own words. Here’s a direct quote from his most recent letter to shareholders:

“We are likely to purchase [700 million shares] just before expiration of our option,” he said. “It is important for you to realize that Bank of America is, in effect, our fourth largest equity investment—and one we value highly.” (Source: Ibid.)

So don’t pay any attention to the bears; the Oracle of Omaha has been proven right on BAC stock.