On the off chance there was any doubt about the matter, Warren Buffett just verified he’s the greatest investor of all time. How so? He’s about to make a trade that will instantly net him a gain of $12 billion on a position in Bank of America Corp (NYSE:BAC).
Granted, the trade is still technically an unrealized profit on BAC stock. But it doesn’t matter.
As long as Buffett — through his Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) fund — doesn’t turn the unrealized gain into a real one, he’ll collect at least $300 million in dividends from the position. Plus, he’ll have the option of exiting the trade and banking the gain anytime he wants.
That’s why they call him the Oracle of Omaha.
The Planets Align
There’s a short backstory to the trade.
Back in 2011, when Bank of America was still struggling to dig its way out of the 2008 subprime mess, Warren Buffett was more than glad to provide it with much-needed funding … on one condition.
Buffett forked over $5 billion then to buy dividend-paying (a 6% yield) preferred shares, plus the rights to buy 700 million common shares in the distant future at a price of $7.14 apiece.
For perspective, BAC stock is presently trading at $24.39, or 240% more than the price Buffett will be paying. With 700 million shares on the table, the total difference between his cost and the trade’s current value is just a tad over $12 billion.
Not bad, even if it took six years to get there.
The timing of Buffett’s decision and news that Bank of America just passed its so-called “stress test” isn’t a coincidence.
With the Federal Reserve effectively saying BofA is financially sound enough to return more capital to BAC stock owners than it’s been able to dish out in the recent past, Bank of America is forging ahead with its plans to gradually raise its dividend from the current annual payout of 30 cents per share to a pace of 48 cents per share beginning in the third quarter of this year.
At an annual payout of 44 cents, it becomes more fruitful — meaning the dividend is bigger — for Buffett’s Berkshire Hathaway to own the common stock rather than the preferred stock. Berkshire will simply swap the latter for the former.
Lessons Learned
In the grand scheme of things, the successful trade from Buffett shouldn’t come as a surprise to anyone. Warren Buffett practices what he preaches, and is impressively disciplined. Two of his axioms really come shining through with this particular trade, though.
1. Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years:
This tip is arguably interchangeable with his similar sounding, “My favorite holding period is forever.” Though he only held the preferred stock and the warrants for six years, the plan all along was to turn it into a long-term trade in BAC stock. It’s just that his entry allowed him to lower his risk and his entry price. He’s still going to hold onto all those common shares indefinitely.
2. Price is what you pay. Value is what you get:
That’s the more poetic way of saying you can’t be afraid to buy into good companies even when their stocks are being beaten to a pulp. Good companies always find a way to recover, and their stocks will eventually snap back to reflect that recovery.
He was able to pay a low price for BAC stock, but the value was always there. It just needed some time to be unleashed.
Looking Ahead for BAC Stock
For those investors that didn’t get into BofA back in 2011 or didn’t get a sweet deal on warrants to purchase the stock, don’t sweat. Everyone has stories about “the one that got away,” including Buffett. Just take the fact that he’s sticking with BAC stock now at face value. He doesn’t have to do that. He’s choosing to do that.
Indeed, with plans to ramp up the dividend to 48 cents per share before the end of next year, Bank of America shares are trading at a forward-looking dividend yield of just under 2%.
That’s not huge, but it’s healthy, and BofA is sporting a very healthy growth trajectory … finally. The annual dividend is apt to keep growing well beyond the 48 cent mark too, barring some sort of major economic headwind that not even Buffett sees on the horizon.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
