If you pay close attention to the financial sector investments in the Berkshire Hathaway portfolio, it becomes clear that these holdings all enjoy a common characteristic. Namely, they are all paying out dramatically lower dividends than they are generating in profits and simultaneously engaging in abnormally large share repurchases.
Bank of America is repurchasing $32 billion in stock, JP Morgan is repurchasing $30 billion in stock, Wells Fargo is repurchasing $25 billion, Goldman Sachs is repurchasing $10 billion, Bank of New York is repurchasing $6 billion, and U.S. Bancorp is repurchasing $4 billion.
Normally, this does not come up unless a company is repurchasing many shares quickly (such as the financial firms noted above), but there is actually a reporting lag in the numbers that you see in financial portals calculating P/E ratios and the like compared to what the underlying reality is.
For instance, right now, Bank of America actually has 9.1 billion shares outstanding. But most finance portals indicate that Bank of America has 9.35 billion shares outstanding. The reason for the discrepancy is that financial portal data follows the government requirement to calculate weighted shares outstanding based on the quarterly report. In other words, when you pull up a Bank of America stock quote between July 1, 2019 and September 30, 2019, you are really receiving numbers that are calculated according to the average number of shares that existed between April 1, 2019 and June 30, 2019.
Most companies issue or repurchase shares slowly, so these mechanics become esoteric points only important to academics, c-suite executives, and government regulators. But when a company is repurchasing shares quickly, what really matters is how many shares exist at the time of your purchase because that is the accurate representation of reality.
Bank of America is earning $28.6 billion in profit. When it is divided by 9.35 billion shares, it appears that each share is earning $2.99 per share in profit. But in actuality, Bank of America has 9.1 billion shares, so the true earnings are more like $3.14 per share right now. Due to the lag in reporting (using the weighted shares average rather than current daily number of shares outstanding), Bank of America’s earnings per share are temporarily understated by 5.02%.
This phenomenon will go on for a while so long as these companies continue to repurchase shares at a rapid clip. It is a big reason why these stocks have climbed in price over the past 2-3 years even though they may have looked fully valued on a P/E basis at the start of the period.
It is just all so…crazy how things can change. Bank in 2014, Bank of America was only earning $4 billion in annual profit due to large mortgage-related settlements and heavy costs associated with slashing its branch presence in low-income areas (as a political point, it’s disingenous to see Bank of America run advertisements about its “community investments” when it has largely moved branches out of the low-income areas that it claims to charitably exist). In any event though, Bank of America is back to being a monster with a $28 billion profit engine. It’s one of the ten most profitable companies in the United States! If it didn’t have to issue over 4 billion shares during the financial crisis it would be earning more than $6 per share, its highest level ever. All that aside, Bank of America is seriously retiring its shares, and Buffett & Co. have taken notice that they represent a better deal than what the forward-facing terms to the investing public might indicate.