Warren Buffett takes $US5 billion punt on Bank of America

Warren Buffett admirers have always thought that the Oracle of Omaha was some sort of genius and now they have proof.

Just like Greek scholar Archimedes, who famously discovered a way to measure the volume of an irregular shape while in the bath, Warren Buffett’s latest “Eureka!” moment also originated in the tub.

Buffett announced this morning that he will invest a staggering $US5 billion into the struggling US financial giant Bank of America, in a deal that will see him receive a discounted parcel of preferred shares in the company and 700 million warrants that will allow him to buy shares in the company over the next 10 years if the company’s share price lifts.

The deal, which is very similar to a $US5 billion investment Buffett made in investment banking giant Goldman Sachs at the height of the GFC, is a bit of classic Buffett bargain hunting.

Bank of America has sold the preferred shares and warrants at a tasty discount – Reuters has estimated Buffett has already made a $3 billion paper profit on the value of his stock.

But some analysts predict that Buffett’s return could be as much as $US5 billion if Bank of America can turn around its recent poor performance and get its share price higher.

“He could well make a 100% return on his investment in a few years,” Berkshire Hathaway investor James Armstrong told Reuters.

“It’s amazing how much a little hug from Mr Buffett is worth these days.”

Bank of America shares have fallen by more than 40% in 2011 due to America’s poor economic conditions and fears that it could be forced to pay huge legal bills on its involvement in the sub-prime crash.

The bank is being pursued over the way its subsidiary Countrywide packaged mortgages into bonds during the crisis, with some commentators tipping the company could be forced to pay billions of dollars in compensation.

Against this backdrop, securing the support of Buffett is a huge coup. Bank of America shares surged by 26% during overnight trade and eventually closed 9.4% higher at $US7.65 – well above the $US7.12 strike price on Buffett’s 700 million Bank of America warrants.