A classic definition of a value investment is a basically sound company that makes a lot of money but has a lousy reputation. In recent years a lot of people have been wondering if Wells Fargo (NYSE: WFC) fits that definition.
Wells Fargo is one of the big monster banks that Americans love to hate. It has also been receiving a lot of bad publicity lately, for having to pay $1.2 billion to settle a US Department of Justice Lawsuit over false claims about FHA loans made during the mortgage hysteria of the last decade.
Such bad press seems to have hurt Wells Fargo’s stock – its share price fell from $54.12 on December 9, to $47.07 on April 7, 2016. Yet the bank’s financial numbers actually look pretty good.
Wells Fargo’s earnings report was a mixed bag
On December 31, 2016, Wells Fargo turned in some pretty good numbers including:
- $86.06 billion in revenues.
- A diluted EPS or earnings per share number of 4.125.
- $22.89 billion in net income.
- A profit margin of 3.19%.
- $92 billion in cash from financing
- $14.77 billion in cash from operations.
Yet it also turned in some pretty bad numbers including:
Cash and short-term investments of just $19.11 billion, in contrast Bank of America (NYSE: BAC) reported $167.1 billion, Citigroup (NYSE: C) reported $133.1 billion and JP Morgan Chase (NYSE: JPM) reported $360.5 billion for the same category in fourth quarter 2015. This seems very low for a major bank and could indicate major losses or other problems.
Wells Fargo also reported a free cash flow of -$5.029 billion, in contrast to Bank of America which reported a free cash flow of $6.15 billion and Chase reported one of $16.17 billion for fourth quarter 2015. To be fair these figures are affected by the settlements Wells Fargo is paying.
Wells Fargo’s Business is Sound
We need to ask ourselves is Wells Fargo’s underlying business sound? There is one number that can tell us if it is and that is revenue which is increasing.
Wells Fargo reported a TTM-revenue of $86.06 billion for fourth quarter 2015. That revenue number was higher than either Bank of America; which reported one of $82.51 billion, or Citigroup which reported a figure of $76.35 billion.
More importantly, Wells Fargo’s revenue has been growing the bank reported a TTM revenue of $84.33 billion in December 2014 and $86.06 billion a year later. Its revenue increased by $1.56 billion over the course of 2015. During the same year Bank of America’s revenue fell by $1.74 billion, BOA reported a TTM-revenue of $84.24 billion at the start of the year, and $82.71 billion at year’s end.
Citi’s revenue also fell over the course of the year; it reported a TTM revenue of $77.22 billion in December 2014 and $76.35 billion a year later, that makes for a drop of $870 million.
This means that Wells Fargo is the only one of the big three US banks that saw a revenue increase in 2015. The numbers show us that Well Fargo’s underlying business; consumer banking, is sound and growing. It seems to be generating enough revenue to make up for the losses and the settlements.
Is Buffett Right about Wells Fargo?
The revenue figures seem to justify Warren Buffett’s faith in Wells Fargo, it is generating a lot of cash and the business is growing. Yet is it a good value investment, for the average person?
I would say yes for three reasons:
- It is undervalued: Wells Fargo had an enterprise value of $540.02 billion and a market cap of $238.96 billion on April 8, 2016. That means there is a lot of room for share value growth there.
- Wells Fargo investors were rewarded with a dividend yield of 3.19% on April 8, 2016. That was higher than the competitors on the same day: BOA reported had a dividend yield of 1.55%, Citi had a dividend yield of .49% and Chase was paying a dividend yield of 3.05%.
- Wells Fargo investors also received a return on equity of 13.61%.
Since its share price is low right now, I’d say Wells Fargo is a buy. If you want to add a bank to your portfolio, you ought to take a look at Wells Fargo. The risk is a little greater than the other banks; but the potential rewards could be a lot bigger, particularly when figures such as cash and short term investments catch back up with the bank’s revenue.
At the end of the day consumer banking and big banks are still a value investment. The monster banks make a lot of money, generate a lot of float, pay decent dividends and they are relatively cheap right now. Unless US Senator Bernie Sanders (D-Vermont); who wants to break up the banks; gets elected president, I would say buy bank stock right now, you won’t go wrong with it.