“Timing has a lot to do with the outcome of a rain dance,” an old cowboy proverb says. That same Old West wisdom could be applied to investing in bank stocks. Banking sector investors have been on a rollercoaster ride in recent years as banks have swung from bulletproof to beleaguered and, in record time, back again.
Despite the volatility in valuations and uncertainty surrounding the economy, though, there are some good reasons to give the right banks – the institutions with strong market positions and solid fundamentals – a fresh look.
At the top of that list is San Francisco-based Wells Fargo (NYSE:WFC), which earlier this month reported second-quarter earnings of $3.9 billion – 29% higher than the same quarter last year. The company chalked up the higher profit to a significant drop in loan losses.
On the downside, WFC’s revenue for the quarter fell 5% to $20.4 billion. The culprits: Mortgage loan originations fell from $84 billion in the second quarter last year to $64 billion this year; and a new federal law limiting overdraft charges reduced the bank’s fee income.
But the quarterly financials tell only a small part of the story. When evaluating whether WFC has a place in your portfolio, mull over these three reasons to hold and three reasons to fold:
Hold
- Wachovia Acquisition. Over the next few weeks, WFC will finish the task of integrating Wachovia into its operations. Wells Fargo acquired the nation’s fourth largest bank in late 2008 in a $14.8 billion stock-for-stock deal. WFC for the first time can stake a claim in the South and East Coast. The combined bank boasts $1.4 trillion in assets.
- Cost-cutting measures. Wells Fargo already has pared back its mortgage banking staff by 3% to reflect the lower demand for new home loans. Completion of the Wachovia integration will save some $500 million a quarter.
- Solid fundamentals. WFC pays a dividend yield of 1.7%. At $28.30, the stock is trading more than 23% above its 52-week low of $23.02 last August. The company’s price-to-earnings growth (PEG) ratio is an enviable 0.75, indicating that the stock is undervalued.
Fold
- Subprime mortgage fines. The Federal Reserve recently fined WFC $85 million – the largest consumer protection penalty ever – for subprime loans made between 2004 and 2008. According to the Fed, WFC loan originators falsified paperwork and steered customers who would have qualified for lower interest mortgages to expensive subprime loans.
- Lack of global diversification. Unlike major competitors such as Bank of America (NYSE:BAC) and Citigroup (NYSE:C), Wells Fargo does not have major international operations. As such, WFC could suffer a greater hit if the U.S. economy experiences another significant downturn.
- Slowdown in brokerage operations. Earnings for WFC’s Wealth, Brokerage and Retirement unit slipped 2% in the second quarter from the first quarter, reflecting lower brokerage transaction volume and lower market activity. Even though the unit’s fee income rose, the stress on brokerage operations has the potential to impact the company’s profitability in the fourth quarter and into 2012.
Bottom line: Wells Fargo is a growing company with significant upside – particularly as it prepares to cash in on its Wachovia investment. The fundamentals are solid and WFC is making great strides toward keeping costs under control. But savvy investors are well served by remembering that old cowboy proverb about timing, because if you wait a bit (perhaps until it slips back to the $27 range), a good value could soon become a better bargain.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.
