Wells Fargo & Co (WFC): Warren Buffett’s Biggest Holding Pays a High Quality Dividend

Thanks to its cheap funding base, Wells Fargo is virtually guaranteed to generate a positive return on its loan portfolio despite today’s low interest rate environment.

In some ways, banks are similar to another type of Buffett’s favorite financial companies – insurance companies. Insurers write new policies to receive money from premium payments, and banks take in money from deposits.

Both types of cash will eventually be paid back in the form of insurance policy payouts or a customer withdrawing funds from the bank. However, the insurer or bank can earn a return with the money before it needs to be given back. Insurance companies invest in stocks and bonds, and banks make loans.

As long as these investments are conservatively managed, insurance companies and banks can make a lot of money from their cheap “borrowed” funds.

Wells Fargo serves one in three households in the U.S., and its convenience and brand recognition are two reasons why it has enjoyed such strong deposit growth. The company maintains industry-leading distribution channels, including storefronts, ATMs, online, and mobile. This allows Wells Fargo to serve customers in more locations than any other bank.

Many businesses that loan money from banks must also maintain a large deposit with their bank if they desire to secure a line of credit, adding to Wells Fargo’s low-cost deposit base. Once a consumer or business opens an account with a bank, switching costs are also created given the hassles involved with closing and transferring accounts, especially when most mega banks are perceived as being somewhat comparable to one another.

Thanks to Wells Fargo’s scale, efficient operations, and low-cost funding, the company maintains a relatively low efficiency ratio. The efficiency ratio essentially measures the percentage of a company’s revenue that is consumed by operating costs; lower numbers are better.

The company’s scale and efficient operations helped it realize a 58.1% efficiency ratio in 2015, which is nearly 10 points better than the average efficiency ratio across all community banks and lower than all but one of its mega-bank peers.

Source: Wells Fargo Investor Presentation

As a result of its cost advantages, Wells Fargo’s return on assets and return on equity metrics are also roughly 30% higher than the average community bank. The company’s asset turnover, as seen below, is also the highest of all mega banks.

Source: Wells Fargo Investor Presentation