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Tuesday, July 29, 2014 - 10:30
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Tuesday, July 29, 2014 - 10:30

Buffett Bought This Bank's Stock For Himself -- Should You?

Tuesday, July 29, 2014 - 10:30am

While most of Warren Buffett 's $63 billion fortune is wrapped up in Berkshire Hathaway (NYSE: BRK-B), he does own other stocks that are beyond the prying eyes of the media.

Buffett is a great investor there's no question there. Berkshire's book value has grown at an annualized rate of nearly 20% for the past half-century. And it would make sense that he makes great investments in his personal portfolio as well.

One sector where Buffett has found value over the past few years is banking. Berkshire's #1 stock holding is Wells Fargo (NYSE: WFC), with Berkshire owning 8.8% of the bank. Back in 2011, Berkshire invested $5 billion in Bank of America (NYSE: BAC) in exchange for preferred shares.

In a 2012 interview with CNBC, Buffett revealed that he personally owns shares of JPMorgan Chase (NYSE: JPM), although Berkshire does not. Buffett has praised JPMorgan's CEO Jamie Dimon for writing the best annual reports in the business.

There's no way to know for sure that Buffett is still an owner of JPMorgan -- but by all indications, he still loves big banks. (My colleague David Sterman recently profiled another reviled big bank that's deserving of investors' attention.)

Berkshire has been buying more and more shares of Wells Fargo since 2012. And earlier this year, the firm locked itself into owning Bank of America's preferred shares until 2019.

Even though the banks have rebounded nicely from their lows after the financial crisis, there could still be further upside. All the major banks have underperformed the market over the past year. Shares of JPMorgan are up a mere 5.1% compared with the S&P 500 Index and the Financial Select Sector SPDR (NYSE: XLF), which are up 17.2% and 10.9%, respectively.

JPM Chart

JPM data by YCharts

This month, JPMorgan beat second-quarter earnings forecasts with $1.46 a share, above the Wall Street consensus of $1.30. The company posted a smaller decline in trading revenues than expected, and its deposits, card sales volume, client investment assets and business banking loan originations were all up year-over-year during the quarter.

Its book value was up to $55.50 at the end of the second quarter, which puts shares trading at a price-to-book (P/B) ratio of just under 1.1. Meanwhile, Wells Fargo is trading at 1.65 times book value. JPMorgan also trades at a forward P/E ratio that's below Wells Fargo and Bank of America.

Assuming the markets for M&A activity and IPOs remain robust, JPMorgan could be one of the biggest benefactors. One of the top advisors when it comes to M&A and IPOs, its J.P. Morgan investment bank remains the top generator of global investment banking fees. During the second quarter, its advisory fees were up 31% year over year and equity-underwriting fees were up 4%.

JPMorgan has been preparing for higher rates for some time. With employment on the rise and GDP growth strengthening, Wall Street expects the Federal Reserve to start raising rates in mid-2015. (My colleague Joseph Hogue looked at why the market may be misreading the Fed's intentions on interest rates.)

JPMorgan has revamped its investment portfolio, where it's been investing in short-term maturities so that it can reinvest as rates rise. The other key is that it has spent the past four years amassing a large deposit base. With deposits of around $1.3 trillion, the bank is the largest in the U.S. by deposits, which is a huge positive. As short-term rates start to rise, JPMorgan can invest these deposits at higher rates, earning more income with little risk.

JPMorgan's dividend pays an enticing 2.7% yield, and the bank expects to complete a $6.5 billion buyback plan that it introduced in April by next spring.

Risks to Consider: JPMorgan is not immune to another slowdown in the global economy. Trading revenues have been in decline across the industry, which could put further pressure on earnings.

Action to Take --> Follow Buffett's lead and buy JPMorgan Chase for upside to $70, a gain of 18% from current levels. The bank is positioned to profit from higher rates and has one of the industry's best CEOs at the helm.

No strategy can protect investors from all market turmoil, but this one comes close. After months of research, my colleague Nathan Slaughter has proven that investing in dividend-paying companies that pay down debt and pay "tax-free dividends" helped shelter investors from even the worst downturns. Not only has the strategy returned an average of 15% per year since 1982, but it's outperformed the S&P during the dot-com bubble and the 2008 financial collapse too. To learn more about his "Total Yield" investing strategy, click here.

Marshall Hargrave does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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