Warren Buffett's company Berkshire Hathaway has built one of the largest and most successful stock portfolios in the world. It's now worth more than $300 billion. It's a great endorsement to be in Berkshire's portfolio. But it can also attract some unwanted attention if Buffett and Berkshire start to sell a stock.
That's the position Bank of America(NYSE: BAC) has found itself in after the conglomerate unloaded more than $7.2 billion of the stock over the past two months. While Buffett and his team of investors at Berkshire are some of the best in the world, I think long-term investors can still buy Bank of America stock. Here's why.
Why is Buffett selling?
Truthfully, I don't know. And the public is unlikely ever to really know why Buffett and Berkshire are selling. But it's important to understand that people running a $300 billion stock portfolio and hedge fund portfolio managers have very different mindsets from retail investors. The "smart money" is beholden to shareholders, and a 5% move in the share price of a stock one way or the other can have much bigger consequences for them than it does for an individual investor.
I also think it's important to understand that Berkshire is not selling these shares at a loss. I calculate an average price of all sales over the last two months of just below $41. If you look at a lot of the buying Berkshire did dating back to 2017, it's in the low to high $20s. We also know that in 2011 Berkshire got warrants equivalent to 700 million common shares at a strike price of $7.14. Those warrants were converted in 2017, so Berkshire could be making massive profits on those as well.
Finally, I think it's worth noting two other things. One is that Berkshire still has a sizable position in Bank of America that makes up more than 10% of its portfolio and is the third-largest position in its portfolio. Also, Berkshire and Buffett might be preparing for either a slowdown in the economy or a drop in the stock market. Berkshire has loaded up on nearly $235 billion of short-term Treasury bills. That's more than what's being held at the Federal Reserve. Banks are cyclical, so Buffett might see this as an opportune time to pare some of his holdings.
The upside
Although Bank of America's stock is up about 35% over the last year, there are plenty of reasons it will continue to move higher. One is purely mechanical. Due to poor balance sheet management, Bank of America loaded up on low-yielding securities before interest rates began to rise two years ago, and many of those bonds are now underwater. At the end of the second quarter, the bank had a more than $850 billion securities portfolio with a blended yield of less than 3%.
As securities roll off that portfolio, the bank can reinvest them into higher-yielding assets. On the company's second-quarter earnings call, management said that roughly $10 billion of securities roll off each quarter, which can be reinvested 300 basis points higher. Additionally, as a result of unrealized paper losses on securities, cash flow hedges, and other financial instruments, Bank of America has roughly $17.6 billion of unrealized losses.
Those unrealized losses detract from tangible common equity and therefore tangible book value, which is what banks trade on. Assuming those unrealized losses are recouped over time, that's another roughly $2.25 of tangible book value right there based on the number of outstanding common shares at the end of Q2 2024. That should push up the value of Bank of America's stock.
The other thing that Bank of America and many banks have going for it is the steepening of the yield curve. After roughly two years, there is no longer an inverted yield curve in which shorter-dated Treasury bills yield more than longer-term ones. While many think banks operate better in a higher interest rate environment, that is not entirely true. Banks also need a steep yield curve because banks tend to borrow short and lend long.
A steep yield curve will translate into higher net interest income (NII), one of the main sources of revenue at Bank of America. NII looks at the difference between what banks make on their interest-earning assets such as loans and what they pay out on their interest-bearing liabilities such as deposits. According to Visible Alpha, analysts believe that NII at Bank of America has inflected. Consensus estimates expect the bank to generate $56.6 billion of NII this year (fully taxable equivalent basis) and then $59.5 billion in 2025.
Bank of America is a buy
It's always important to look at what the greats are doing and use their moves to guide or reevaluate your thesis on individual stocks. However, one must always remember that institutional investors have a different mindset from retail investors and you should not follow every move blindly. Given that Bank of America is set to recoup lost tangible book value and the upward trajectory of NII, I think long-term investors can still buy the stock despite Berkshire selling a portion of its stake.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has a position in Bank of America. The Motley Fool has positions in and recommends Bank of America and Berkshire Hathaway. The Motley Fool has a disclosure policy.
