Better Buy: Berkshire Hathaway vs. Wells Fargo

By Markets Fool.com

Continue Reading Below

Image source: Motley Fool Editorial, via Flickr

Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) and Wells Fargo (NYSE: WFC) share at least one very influential investor in common: Warren Buffett. Buffett is the longtime CEO of Berkshire Hathaway and controls about a third of the voting power of that company. In addition, under Buffett's direction, Berkshire Hathaway owns nearly 10% of the outstanding shares of Wells Fargo.

In a very real sense, Buffett himself gives you a great answer to the question of which is a better buy: If you like them both, go ahead and own shares of both. Both Berkshire Hathaway and Wells Fargo have fabulous traits that make them worth owning. Still, if you've only got room in your portfolio for one of the two, keep on reading to uncover key reasons why you might choose one over the other.

Which company has a stronger financial foundation?

During last decade's financial meltdown, Wells Fargo's CEO famously argued against the TARP bailout, but the bank was strongly encouraged to take the money and ultimately acquiesced. Berkshire Hathaway, on the other hand, was busy providing bailout funding of its own. As Warren Buffett famously said, "Only then the tide goes out do you discover who's been swimming naked."

Continue Reading Below

In addition, while both companies are technically in the financial industry -- Wells Fargo as a bank and Berkshire Hathaway as an insurance company -- beneath that surface sit two very different companies. Wells Fargo's business is highly concentrated in financial services, while Berkshire Hathaway owns a fairly diversified stream of businesses. Berkshire Hathaway's subsidiaries include Duracell batteries, Benjamin Moore paints, See's Candy, Helzberg Diamonds, BNSF Railroad, and dozens of others.

Berkshire Hathaway wins in terms of having a stronger financial foundation because of how well itnavigated the financial crisis and its extremely diversified income stream.

Which company rewards its shareholders better?

Dividends provide a direct payment to shareholders for the financial risks they take by investing in a company's stock. In the absence of a dividend, the only way for shareholders to actually make use of the rewards of their ownership is to be willing to sell their stakes. If they do sell some or all of their shares, they're either no longer shareholders or have a lower ownership stake.

Wells Fargo currently pays a dividend of $0.38 per share per quarter, and its dividend is now higher than it was before the financial crisis. That dividend gives it a yield of nearly 3.2%. With a payout ratio of around 37% of earnings, it has room to continue increasing its dividend over time as its business continues to grow. In fact, the Fed approved Wells' most recent dividend hike.

Berkshire Hathaway, on the other hand, pays no dividend, choosing instead to entrust its cash flow to Warren Buffett's investment prowess. While Buffett is arguably one of the world's greatest investors, even he has admitted that it's tough to get market shattering returns when you have to manage as much money as he does. While this might sound odd, think about it this way: It's a lot easier to double your returns when you initally earned $1 instead of $100.

From the perspective of its willingness and ability to directly reward shareholders for the risks they take by owning stock, Wells Fargo wins.

Which company looks like a better bargain today?

Value oriented investors like Buffett look to buy a company's earnings power at a discounted price. Wells Fargo trades at 11.9 times its recent past earnings and is expected to grow those earnings at about an 8.7% annualized pace over the next five years. Berkshire Hathaway, on the other hand, trades at about 14.5 times its recent past earnings and is expected to grow those earnings at about an 8.8% annualized pace over the next five years.

From a valuation perspective, people looking to buy Wells Fargo's shares are getting a little bit more current earnings power per dollar of investment than those looking to buy Berkshire Hathaway. In addition, with the two companies' expected growth rates nearly identical over the next five or so years, the justification for Berkshire Hathaway's higher valuation stems from its stronger financial foundation.

Note that Wells Fargo's stock will cost you about $49 per share, and Berkshire Hathaway's Class B stock will cost you about $146 per share. The difference in raw share prices shouldn't alarm you though, as one B share of Berkshire Hathaway represents nearly $10 of earnings power while one share of Wells Fargo represents around $49. In today's era of low commissions at discount brokers, buying an "odd lot" (fewer than 100 shares) is easy and cheap.

On this front, investors face a clear trade-off between a somewhat better bargain with Wells Fargo and the tremendous reputation of Warren Buffett and Berkshire Hathaway -- and its unmatched ability to provide bailout funding during a financial crisis instead of potentially needing to take one. The value hound in me is tempted to give this round to Wells Fargo. But Berkshire Hathaway does not look overpriced either, making it a reasonable contender for an investor that wants that extra assurance that comes from knowing that Warren Buffett works directly for Berkshire Hathaway.

You can invest like Buffett and own both

As an individual investor in today's era of low commissions, it's quite possible for you to buy a few shares of each company and own a bit of both Berkshire Hathaway and Wells Fargo. Warren Buffett is certainly happy to own both. After all, he is chairman, CEO, and major shareholder of Berkshire Hathaway while calling Wells Fargo his favorite bank stock and controlling around 10% of the bank's shares. With an endorsement like that on top of everything else both companies have going for them, either Wells Fargo, Berkshire Hathaway, or both would make a fine addition to an investor's portfolio.

Personally, as an investor that prioritizes dividends and appreciates deeper values for my investment, I own shares of Wells Fargo but not Berkshire Hathaway, and at today's prices, I'm seriously considering buying more after the Fool's disclosure policy allows. Still, a Berkshire Hathaway with Warren Buffett at the helm and a valuation that's cheaper on a trailing earnings basis than the overall S&P 500 index, paints a fairly compelling case for those less concerned about dividends or absolute bargain prices.

The $15,834 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.

Chuck Saletta owns shares of Wells Fargo. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.