Warren Buffett is a big fan of bank stocks. His holding company, Berkshire Hathaway, has several major investments that are directly exposed to the financial sector.
Two of Buffett’s positions are particularly attractive right now. One bank is a deep value play, while the other offers compelling long-term growth potential.
Bank stocks can see their valuations fluctuate wildly during various economic ups and downs. Citigroup (NYSE: C), for instance, has seen its price-to-tangible book value — a metric that gauges how much the market is willing to pay for a company’s net real assets — range from 0.5 to 6.5 over the decades.
Following the 2008 financial crisis, the valuations for banks fell precipitously across the board. While stocks like Wells Fargo and Bank of America have seen their valuations hover between 1 and 2 times tangible book value, Citigroup stock remains in the penalty box. On a price-to-tangible book basis, Citigroup shares trade at a 50% discount to Wells Fargo and Bank of America.
Someone at Berkshire, maybe even Buffett himself, noticed this valuation gap in the first quarter of 2022, initiating a $2.8 billion position — one of Berkshire’s biggest bank stock positions. For this investment to pay off, Citigroup must prove that it can generate peer-average returns on its asset base. If it fails to do this, the market will continue to place a discount on its valuation. Last quarter, for example, Citigroup posted a return on equity of just 3.8%. Bank of America, meanwhile, had a return on equity of 8.7%, while Wells Fargo came in at 10.2%. It shouldn’t be surprising, then, that the market is willing to pay more for Wells Fargo and Bank of America stock.
Citigroup has certainly set the bar low for performance. And its current chief executive officer, Jane Fraser, has struggled to get a multiyear restructuring effort to be reflected in the bank’s financial performance. Yet this is perhaps why Buffett and Berkshire have a multibillion-dollar position in Citigroup. The bank has long underperformed industry metrics, but the stock’s current valuation more than reflects that. Investors simply don’t have to pay that much to gain exposure to Citigroup’s turnaround effort. And if returns are a function of what you pay, Citigroup should be a top contender for any value investor’s portfolio.
C Price to Tangible Book Value data by YCharts
While it’s one of Berkshire’s smaller positions, Buffett is still bullish enough on Nu Holdings (NYSE: NU) to retain a $900 million investment. It’s not hard to see why Buffett and his team are willing to stake nearly $1 billion on the company. For a bank stock, Nu has tremendous long-term growth potential.
Nu’s entire business model is to disrupt the highly consolidated Latin America banking sector. For decades, the region was dominated by a handful of competitors that charged high fees for simple services. This industry consolidation reduced the incentive to innovate. Incumbents simply weren’t interested in shaking up a situation that, for them, was quite profitable.
Nu’s vision was to offer low-cost, easy-to-understand financial products directly through a smartphone. With no need to maintain physical branches, its structural cost base was lower than incumbents’. It could also innovate and roll out new products to customers much faster than the competition. In its first decade of operation, it went from zero customers to nearly 100 million.
Nu has shown a tremendous ability to convert entire countries to its platform. Roughly half of all Brazilian adults, for example, are now Nu customers. The bank has more recently entered into Mexican and Colombian markets, but there’s still a long runway of potential growth considering Latin America boasts more than 600 million residents. Future markets won’t be as attractive as Brazil, or even Mexico or Colombia. Average incomes are lower elsewhere, and competition varies across different regions. But Nu is playing the long game, establishing a reputation for trust and innovation in a market that has long lacked both.
Valued at roughly $55 billion, Nu doesn’t have the huge upside of a complete start-up. But it also has an enviable track record of success that few early-stage growth companies have. Investors must remain patient for this long-term story to play out, but Nu is a high-quality business with a strong future. And it just happens to be backed by one of the most successful investors in history: Warren Buffett.
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Citigroup is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America and Berkshire Hathaway. The Motley Fool recommends Nu Holdings. The Motley Fool has a disclosure policy.
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