Warren Buffett is Smarter than You are; No, Really, He is

Last week somewhere between an earthquake and a hurricane, Bank of America (BAC) seemed like a stock headed to zero, especially to those of us who have previously, namely 2008, witnessed such behavior in bank stocks. Last Monday BAC shares had been hit with a crescendo of selling owing to a number of factors, not the least of which was a blog post claiming that BAC was roughly $200 billion under-capitalized. The implication was, so the rumor flew, that BAC would, if not go under completely, dilute shareholders to oblivion with a capital raise many times larger than the bank's recapitalization during the last banking crisis, from which, of course, we have yet to recover. Investors exited from the shares, and the short-sellers flowed in, borrowing shares of BAC just for the purpose of selling them and selling them and selling them. Then Wednesday morning, so the story goes, Warren Buffett emerged from the bathtub with an idea to invest in BAC, placed a call to BAC's CEO Brian Moynihan, and, bingo!, a mere twenty-four hours later, the greatest investor of all time owned $5 billion of preferred shares of BAC stock sporting a 6% annual dividend yield.

BAC shares jumped on Buffett's purchase but may revisit lows.

Warren Buffett has played deus ex machina in the past for the markets. As a deep value investor, he invested heavily in General Electric (GE) and Goldman Sachs (GS) during the oh-so-recent unpleasantness of 2008, when short-sellers raided the firms over liquidity and solvency concerns similar to the fears stirred last week about Bank of America. The difference? For both the GE and GS deals, Buffett received a nice, round 10% annual dividend yield, much higher than the still impressive 6% from the BAC deal. That difference shows me that the banks and businesses in general are much better capitalized than they were in 2008; otherwise, Buffett would have been able to demand a higher yield than 6%. Now, don't misunderstand me. As a BAC investor, I'm not thrilled with paying 6%, even to Warren Buffett, for capital that Brian Moynihan has claimed and claimed again that the bank did not need. He was, of course, protesting a bit too much.

The financial media has been split over the deal. Of course, the terms are good for Buffett, but in a nearly no-rate interest environment, 6% is an expensive bill for Bank of America to pay every year for under-needed capital. Of course, the shares rallied considerably in an ugly market Thursday and rallied nicely into the weekend to close the week at about $7.75. Not bad, I'd say, for a company whose shares traded at nearly $6 recently. I think the stock will retest its recent lows, despite how respected Warren Buffett is as an investor. Yes, he is hands down, the greatest stock investor of all time; yes, over his investing career, he turned roughly $200,000 into $45 billion; yes, he has an uncanny ability to recognize value where Wall Street doesn't. Yes, yes, yes, but Warren Buffett is no trader, as he himself will admit, and in both the GE and GS deals he did not call the bottom of the stock. He does not call bottoms. He simply holds onto shares of good companies forever and has more patience than the short-sellers and can outlast any recession or depression or credit crisis. Whereas I hold a (nearly) permanent portfolio, Warren Buffet devotees hold a (truly) permanent portfolio.

What's the plan, then? You could either buy now and hold as long as Buffet, or you could wait for the stock to test the lows and then buy, because, as I mentioned, Buffett doesn't usually buy at the bottom. Even if $6 is the bottom, traders and short-sellers will make sure BAC tests that low at least once more. I first recommended BAC shares on June 21, 2011, at a price of about $10.50. I liked the stock then, and I love it now at about $8.00. I will add to my shares closer to $6.00 and hold them for (almost) as long as Buffett. If the shares make their way down to a 5-handle, I'll double my position. Either way, as I have mentioned in previous articles, without the banks' participation, any substantial recovery in the stock market or the economy is as evanescent as the bubbles in Buffett's bath.