Many investors who focus on a low price-to-earnings (P/E) ratio and high dividend yield in their search for value will have a hard time swallowing the maxim legendary investor Warren Buffett lives by: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.
Today, I’m considering whether FTSE 100 bank Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) is a wonderful company, and whether its shares are trading at a fair price.
A wonderful company?
Wells Fargo is a shining example of what Buffett considers to be a wonderful bank. Indeed, long-term supporter Buffett has repeatedly increased his shareholding over the past two years to the extent that ‘the stagecoach bank’ has become the largest holding of his Berkshire Hathaway investment group.
Wells Fargo and Lloyds have some things in common — beyond the shared history of horses in their logos. Both are essentially traditional lenders, providing bread-and-butter services to individuals and businesses. Both are their countries’ biggest mortgage lenders.
It’s taken time for Lloyds to recover from a shotgun marriage to insolvent HBOS during the financial crisis, but the black horse is starting to rear proudly again. Lloyds has returned to profit this year; the government has begun selling the taxpayer’s shareholding; and the prospect of the company resuming dividends moves ever closer.
Lloyds may not yet measure up against Wells Fargo on the financials Buffett rates highly, such as cost of funds and return on equity, but the UK bank is certainly heading in the right direction.
There is, though, a bit of a question mark against Lloyds in another area that’s also very important to Buffett. He favours passionate managers of impeccable personal integrity, who have shown a long-term commitment to their company. Buffett sees these qualities as particularly relevant in the world of banking, where the inherent leverage of the business “magnifies the effects of managerial strengths and weaknesses”.
Wells Fargo’s chief executive, John Stumpf, is a 31-year veteran of the bank. In contrast, Lloyds’ boss, Antonio Horta-Osorio, joined the company as recently as 2011.
In Horta-Osorio’s favour, he had shown a long commitment (from 1993) to the Banco Santander group — and achieved considerable success — before his move to Lloyds. In fact, it’s been claimed the only reason he left Santander was because it became apparent to him he would never progress to the chief executive’s seat, due to the control of the bank’s Botin family dynasty.
A fair price?
Lloyds certainly has some of the characteristics of Buffett’s favourite wonderful company, Wells Fargo, and Antonio Horta-Osorio may well have the qualities Buffett seeks. In short, while Lloyds still has legacy issues to work through, the bank could emerge as a wonderful company.
At a share price of 75p, Lloyds is trading at 1.5 times book value — a price that Buffett has been happy to pay for Wells Fargo shares.