Wells Fargo (WFC) is Warren Buffett’s largest holding, and he first bought into the company in 1989. Buffett owns businesses with lengthy operating histories, durable competitive advantages, and excellent management teams, and Wells Fargo is no exception.

Warren Buffett even added to his stake in the company during the fourth quarter of 2015, making the stock an even more timely idea. While we don’t own many financial companies in our Top 20 Dividend Stocks portfolio, Wells Fargo is one we are fond of.

Despite the negative stigma attached to banks following the financial crisis, these companies are generally in great financial shape and appear relatively undervalued compared to the market. With a dividend yield greater than 3% and mid- to upper-single digit dividend growth potential, Wells Fargo is worth a closer look.

Business Overview

Wells Fargo was founded in 1852 and was the third-largest bank in the country as measured by assets at the end of 2015. Wells Fargo’s 90 different business lines collectively generated over $86 billion in revenue last year from a diversified mix of banking, insurance, investment, mortgage, and consumer and commercial finance services.

Unlike many big banks, Wells Fargo has little exposure to investment banking and trading operations. Instead, the business focuses on simple lending businesses (e.g. mortgages, auto loans, commercial financing) and fee income.

Wells Fargo’s revenue is split nearly equally between traditional loan-making (53% of revenue), which generates net interest income from a 50/50 mix of commercial and consumer loans, and noninterest income (47% of revenue) from brokerage advisory services, commissions, mortgage originations, card fees, deposit service charges, and more.

The company serves more than 70 million customers through its network of more than 8,600 store locations and 13,000 ATMs, as well as its website and mobile banking application.

Business Analysis

Banks primarily gather deposits and loan them out for interest income. As borrowers, consumers and businesses are most concerned with getting access to dependable financing at the lowest interest rate possible.

In other words, banks are largely commodity businesses, and the lowest cost operator usually survives the longest in commodity markets. As one of the biggest banks in the country, Wells Fargo has numerous cost advantages, which begin with its track record of gathering low-cost deposits from consumers and businesses that it can lend out at higher interest rates.

According to Wells Fargo’s annual reports, the company’s total deposits have grown from $3.7 billion in 1966 to $1.2 trillion in 2015, representing growth of 12.6% per year over that period. As seen below, Wells Fargo’s deposits have grown at a healthy high-single digit rate in recent years as well. The company has more retail deposits than any other bank in the country and is ranked third overall in total deposits.

Source: Wells Fargo Investor Presentation

Importantly, Wells Fargo funds most of the loans it issues with its deposits. The company was paying just 0.08% on its deposits as of the fourth quarter of 2015, and its total funding cost including all sources was only 0.25% in 2015.

Thanks to its cheap funding base, Wells Fargo is virtually guaranteed to generate a positive return on its loan portfolio despite today’s low interest rate environment.

In some ways, banks are similar to another type of Buffett’s favorite financial companies – insurance companies. Insurers write new policies to receive money from premium payments, and banks take in money from deposits.

Both types of cash will eventually be paid back in the form of insurance policy payouts or a customer withdrawing funds from the bank. However, the insurer or bank can earn a return with the money before it needs to be given back. Insurance companies invest in stocks and bonds, and banks make loans.

As long as these investments are conservatively managed, insurance companies and banks can make a lot of money from their cheap “borrowed” funds.

Wells Fargo serves one in three households in the U.S., and its convenience and brand recognition are two reasons why it has enjoyed such strong deposit growth. The company maintains industry-leading distribution channels, including storefronts, ATMs, online, and mobile. This allows Wells Fargo to serve customers in more locations than any other bank.

Many businesses that loan money from banks must also maintain a large deposit with their bank if they desire to secure a line of credit, adding to Wells Fargo’s low-cost deposit base. Once a consumer or business opens an account with a bank, switching costs are also created given the hassles involved with closing and transferring accounts, especially when most mega banks are perceived as being somewhat comparable to one another.