Bank of America is the second-largest holding in Berkshire Hathaway's large equities portfolio.
Warren Buffett is one of the greatest investors of all time, and his success helped build his company Berkshire Hathaway into one of the largest conglomerates in the world.
When researching new stocks, Buffett says he looks for stocks with strong financial performance. But he's not just looking for good performance over one or two years. He wants consistency over five to 10 years. Buffett wants the stocks he invests in to be able to generate strong financial performance over and over and in a variety of different economic scenarios.
One of the largest holdings in Berkshire's portfolio,Bank of America (BAC 1.16%), has certainly shown its ability to do this over the last decade, especially when you look at one key financial metric that happens to be a big reason Buffett loves Bank of America.
A history of operating leverage
In just about any industry, if you want to improve profitability and please shareholders, then the easiest way to do this is to grow revenue faster than expenses, also known as generating positive operating leverage.
Now, this is easier said than done, especially as companies balance prudent expense management with the need to invest back into their business and position themselves for future success. But Bank of America has been able to generate positive operating leverage pretty consistently since 2015.
Image source: Bank of America.
Prior to the pandemic, Bank of America generated 18 straight quarters of positive operating leverage. Then when the pandemic hit, it failed to do this in 2020 and the first quarter of 2021 as it faced elevated expenses and larger reserves for loan losses due to the unprecedented situation that arose at the very beginning of the pandemic. But now, the bank has resumed its streak and just completed its sixth straight quarter of positive operating leverage in the fourth quarter of 2022, despite a difficult operating environment.
Can Bank of America keep it going?
Banks have a ton to manage, including credit, interest rates, the external economic environment, regulatory capital requirements, and their other fee-based businesses, which can make controlling expenses and revenue difficult. Bank of America CEO Brian Moynihan has said in the past that if management doesn't do anything, expenses will automatically grow 1% to 2% annually.
Now, it's possible that generating positive operating leverage could be difficult in the current quarter. Management expects expenses to move to $16 billion in the first quarter, which would be up from $15.5 billion in the fourth quarter.
Furthermore, management is guiding for net interest income (NII), the money banks make on loans and securities after funding those assets, and a key revenue driver to fall from $14.8 billion in the fourth quarter to $14.4 billion in the current quarter. That's not a great sign, but there are other factors that could help the cause.
For the year, Bank of America expects expenses to trend back lower and finish 2023 around $62.5 billion, which would only be about 1.8% higher from 2022 and reflect pretty solid expense management when you think about some of the inflationary pressure banks are dealing with. While management did not provide full-year NII estimates, I would still expect the bank to deliver decent NII growth over 2022, even if it's not as strong as initially expected.
A strong emphasis on operating leverage
While Bank of America wasn't able to generate positive operating leverage in 2020, and while the current quarter might be more difficult, the bank has consistently generated positive operating leverage since 2015. Furthermore, you can tell that Moynihan places a great deal of emphasis on operating leverage.
As someone who focuses on consistent financial performance, I am sure Buffett and Berkshire really appreciate the bank's attention to detail in expense management and continuing to grow revenue faster than expenses.
It's very likely one of many reasons that Berkshire likes the stock enough to make it the second largest in its equities portfolio.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has positions in Bank of America. The Motley Fool has positions in and recommends Bank of America and Berkshire Hathaway. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway, short January 2023 $200 puts on Berkshire Hathaway, and short January 2023 $265 calls on Berkshire Hathaway. The Motley Fool has a disclosure policy.
