Financial services companies are notorious for their complexity and opacity, which confound prediction. Confusingly, Warren Buffett has recently praised banks for their clarity and safety as investments. Could the Oracle of Omaha be wrong, or is Mr. Buffett right as usual?
Below, I will show why active investors should underweight or abstain from financials as an industry. This includes financial stocks like Wells Fargo & Company (NYSE: WFC), U.S. Bancorp (NYSE: USB), Bank of America Corp (NYSE: BAC), and Goldman Sachs Group, Inc. (NYSE: GS) that are long positions for Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A). Speculators can try to place a cheap bet by looking at valuation, but these bets should be small, regardless of assurances made by the Oracle of Omaha.
According to Wells Fargo Chief Financial Officer Tim Sloan, "Mortgage lending will likely continue to decline as an increase in mortgages for home purchases fails to offset a slowdown in refinancings." Wells Fargo is the currently the largest mortgage lender in the U.S., and investors have been wondering if the bank can sustain its high profits sparked by a mortgage refinancing boom due to low interest rates. Sloan also said that Wells Fargo still has a "good opportunity" to refinance eligible homeowners. Wells Fargo generated $125 billion in loans during the fourth quarter, a 10% decline from the third quarter. Wells Fargo currently has a P/E ratio of 10.44 and pays a 2.8% dividend yield.
Meanwhile, U.S. Bancorp has invested $930 million in renewable energy projects since 2008. The company invested nearly $250 million in 2012 alone. U.S. Bancorp is the fifth largest commercial bank in the U.S., and the company is expected to earmark over $1 billion in renewable projects over the next five years. U.S. Bancorp announced it will team up with SunPower Corporation (NASDAQ:SPWR) to invest $100 million to install solar-power systems in over 3,000 homes in the U.S. U.S. Bancorp has a P/E ratio of 11.98 and dividend yield of 2.3%.
Bank of America Corp (NYSE:BAC) and Wells Fargo are drawing criticism over their handling of insurance payouts to homeowners impacted by the devastation caused by Hurricane Sandy. According to The Wall Street Journal, they are being pressured by New York Governor Andrew Cuomo to speed up the release of insurance money. Insurance payments are often held by banks and released in stages in cases where properties are mortgaged. According to the article, "Mortgage companies say they operate that way to safeguard the lender's collateral and protect homeowners from unscrupulous contractors." Bank of America currently has a P/E ratio of 49.27 and dividend yield of .30%.
Harvey Schwartz, Chief Financial Officer of Goldman Sachs Group, predicted that the banking industry’s average return on equity (ROE) will exceed 12% as some firms shrink or exit businesses. Schwartz said, "I think the industry will migrate to higher returns because it will have to." Goldman Sachs, the fifth largest U.S. bank in terms of total assets, saw a 3.7% increase in return on average common shareholders' equity between 2011 and 2012. The bank generated a 10.7% percent return on average common shareholders’ equity in 2012. Schwartz said the 2012 figure was “not particularly aspirational,” and that Goldman Sachs does not have enough information to provide an accurate ROE target. Goldman Sachs has a P/E ratio of 10.95 and dividend yield of 1.30%.