Wells Fargo & Co (NYSE:WFC) shares are down 12.3% since September 1 as details of the company’s accounting fraud have come to light. At this point, WFC stock investors are asking themselves two questions: Should I sell my shares, and how much lower can WFC stock go?
Unfortunately, there are still a number of unknowns when it comes to WFC stock and the potential fallout from the fraudulent accounting scandal. At this point, WFC has paid $185 million in fines. It could get much worse before it gets better.
“Several additional investigations, lawsuits and fines have been announced, and some clients have pulled business from Wells, making the ultimate financial impact difficult to predict,” Raymond James analyst David Long wrote last week. In the same note, Raymond James downgraded WFC stock from “market perform” to “underperform.”
But, WFC stock investors are now left to determine what exactly “underperform” means. WFC stock has clearly been punished in the market. While WFC stock has declined 12.3%, “Big 4” U.S. bank rivals JPMorgan Chase & Co. (NYSE:JPM) and Citigroup Inc (NYSE:C) have at least delivered minimal gains since September 1, and Bank of America Corp (NYSE:BAC) is down less than 1%. At this point, has WFC stock been punished enough?
The WFC Stock Premium
Ever since the Financial Crisis, WFC has carried the reputation that is was the “responsible” one among the largest banks in the U.S. While other banks were gambling on subprime MBS derivatives, WFC was doing what typical banks do — making loans and collecting interest. This reputation is responsible for WFC stock trading at a valuation premium to its peers since the Financial Crisis.
The WFC scandal news broke on September 8 when the Consumer Financial Protection Bureau (CFPB) and the Los Angeles City Attorney, along with the Office of the Comptroller of the Currency (OCC) fined WFC $185 million related to the company opening more than 2 million fraudulent bank accounts.
There’s an old Wall Street bank stock rule of thumb that says investors should buy when price-to-book ratio dips below 1.0 and sell when it climbs above 2.0. As of September 8, WFC stock traded at a price-to-tangible book value (P/TBV) of 1.82. For comparison’s sake, JPM stock traded at a 1.40 ratio. BAC stock traded at a 0.97 ratio. Citigroup stock traded at a 0.75 ratio.
Raymond James is now anticipating WFC’s EPS will decline 1.5% year over year in fiscal 2017. However, conservatively assuming earnings are unaffected by the scandal, WFC stock could still take a big hit if it loses its “good behavior” premium.
WFC’s “Big 4” peers have an average P/TBV of 1.05. If WFC stock were to re-rate to be in line with its peers, it would trade down to a share price of $28.64.
What Should WFC Stock Investors Do?
That $28.64 number is really scary for WFC stock owners. Even after the 12.3% decline, WFC stock is still trading at around $45. However, there’s no question the the fraud scandal has sent some shareholders running for the hills. But, where are they putting their money?
Among the large-cap U.S. money center banks, Citigroup, SunTrust Banks, Inc. (NYSE:STI) and First Republic Bank (NYSE:FRC) are the three best-performing stocks since the WFC scandal broke.
WFC stock may still have significant downside, considering additional fallout from the fraud scandal. The majority of economists are expecting the next Federal Reserve interest rate hike in December. It may be time for WFC stock investors to consider other options in the banking space.
Nobody knows just how bad the fallout from the scandal will ultimately be. If WFC stock loses its premium valuation relative to its Big 4 peers, the stock could eventually be headed below $30/share.
As of this writing Wayne Duggan was long C stock.
