If Warren Buffett Loves Wells Fargo So Much, Why Is He Selling the Stock?

Since news of Wells Fargo's (NYSE: WFC) fake accounts scandal broke, Warren Buffett has been asked several times whether he still thought the bank was a good investment. At Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) most recent annual meeting in May 2018, Buffett was even asked by a shareholder at what point enough would be enough and Berkshire would get rid of the stock.

Not only has Buffett repeatedly defended Wells Fargo as a good long-term investment, but he's even gone so far as to say that he thinks it will do quite well in the years ahead. Also, in May, Buffett told CNBC that he thought Wells Fargo would outperform the other big U.S. banks over the next decade.

Berkshire continues to sell shares in the bank

Despite Buffett's positive comments about the bank, Berkshire sold nearly 10 million shares of Wells Fargo during the third quarter, but that isn't the whole story. The company has been gradually selling millions of Wells Fargo shares for some time now. Here's a look at how the Wells Fargo investment has shrunk since the beginning of 2017.

Since it started reducing its Wells Fargo position in 2016, Berkshire's ownership has gone from more than 506 million shares to the current level of 442.4 million. That's a reduction of roughly 13%. However, it's not because of the bank's scandals or any other negative reason.

Why is Buffett selling?

The reduction in Berkshire Hathaway's Wells Fargo investment is for one reason only: to keep Berkshire's ownership stake comfortably less than 10% of the bank's outstanding shares.

Why 10%? I won't go into too deep a legal discussion here, but to make a long story short, owning more than 10% of a bank comes with significant regulatory headaches. In a nutshell, holding 10% or more of a company's shares creates a presumption of control, and because banking is such a highly regulated industry, it's not desirable for Berkshire to own more than 10% of Wells Fargo.

To be perfectly clear, Berkshire is allowed to own more than 10% of Wells Fargo. An investor can own more than 10% but less than 25% of a banking institution by issuing a commitment to remain a passive investor. In fact, Berkshire applied to the Federal Reserve in 2016 for permission to increase the stake beyond 10%.

However, Berkshire quickly decided that owning more than 10% of Wells wasn't in its best interest. As Wells Fargo buys back shares, Berkshire's percentage ownership automatically increases over time even if it doesn't acquire any additional shares. That's why the company chooses to gradually sell chunks of its Wells Fargo stock -- doing so allows the company to maintain its ownership at a comfortable sub-10% level.

Furthermore, it's worth mentioning that Wells is buying back shares aggressively this year, presumably to take advantage of its depressed valuation. So investors should expect this gradual selling to continue, and it may even accelerate because of Wells' increased buyback rate.

The bottom line: Don't read too much into it

Sure, it's easy to jump to conclusions by simply reading Berkshire's SEC filings (or an article about what the company bought and sold) and assume Buffett is losing faith in Wells Fargo. This is especially true for the most recent quarter -- Berkshire added shares of rival banks JPMorgan Chase, Bank of America, and others, while Wells Fargo was the only bank investment that decreased.

However, don't read too much into the sale. If anything, I'd interpret this as a bullish call on Wells Fargo. Buffett is plowing billions of dollars into the banking sector and still chooses to maintain a near-maximum stake in Wells.

However, I'm not saying that Wells Fargo is a great investment right now, and I've written before that there are certain unanswered questions that make me hesitant to invest, even at the current valuation. Rather, the bottom line is that if you're a follower of Warren Buffett's stock moves, it would be the wrong interpretation to believe Buffett prefers his other bank stocks to Wells Fargo.

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Matthew Frankel, CFP owns shares of Bank of America and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.