Is Wells Fargo (NYSE:WFC) stock a value play, or a value trap? The bank’s 5% dividend yield may be tempting for income investors. But with the Federal Reserve’s recent rate cut, money center banks could see an impact to their bottom lines. And shares weren’t exactly setting the world on fire before the market turmoil, either.
Shares were already trending lower as the market was setting new highs. Wells Fargo stock hit a 52-week high of $54.75 per share on Nov. 29, but since January had been heading south, below the $50 per share price level.
The reason? Lingering issues from the company’s fake accounts scandal from a few years back. The company had to pay $3 billion to settle claims related to the scandal. The company still operates under an imposed asset cap. This regulatory fetter has stymied balance sheet growth.
This controversy may be in the rear-view mirror. But a tarnished reputation continues to impact the company. As InvestorPlace’s Dana Blankenhorn discussed Feb. 25, new CEO Charles Scharf has his work cut out for him.
It remains to be seen whether Scharf can help salvage the bank’s reputation. Yet, with bank stocks heading lower, it’s more uncertain whether shares will rebound in the near term. So, let’s dive in, and see why it’s probably best to stay on the sidelines with Wells Fargo stock.
Can WFC Stock See Earnings Improvements As Rates Fall?
The Fed’s emergency actions may help to stabilize markets. But for money center banks, they could mean a big headwind for near-term profitability. Bank stocks took a dive after the announced 50 basis point rate cut on March 3. WFC stock fell more than 4% that day. Net interest margins are going to take a hit due to this Fed move. Yet, that may not be the only negative factor weighing on profitability going forward.
It all depends how the coronavirus from China plays out. If we see a V-shaped recovery, perhaps today is darkness before the dawn. But, based on the International Monetary Fund’s gloomy forecast, we could see a material economic slowdown. In short, there’s a good chance Wells Fargo won’t be able to improve profitability.
Yet, the company’s aggressive buyback policy could help shore up earnings per share. As this Seeking Alpha contributor recently discussed, as its stock price falls, it can buy back even more shares. This could mean earnings per share stay the same, even if profits decrease.
Due to the asset cap, buybacks have been the company’s main way to increase shareholder value. But perhaps this is a blessing in disguise. Wells Fargo may be less hard hit by a recession, as it was not aggressively reinvesting its profits.
Yet, that’s not to say WFC stock is immune from an economic downturn. If the bank cuts its dividend or suspends buybacks, shares could fall further.
Handicapping Future Dividends and Buybacks
What happens to WFC stock if the bank cuts its dividend? Or decides to buy back less shares going forward?
Is a dividend cut likely? As InvestorPlace’s Mark Hake discussed Feb. 21, we won’t know about dividend changes until July. That’s when the Federal Reserve will approve or reject the company’s return of capital plans for the year. Even if earnings stay flat, the company may still be able to increase the dividend, thanks to the reduced share count.
But if earnings take a big hit due to rate cuts, they may be unable to increase the dividend. It remains to be seen whether reduced odds of a dividend increase are already priced into shares.
How about buybacks? As of the end of 2019, Wells Fargo’s fully phased-in Tier 1 ratio was 11.1%. That’s well above the regulatory minimum of 9%. But the company’s ratio has been coming down in recent years.
The Federal Reserve has simplified capital rules for the 2020 stress tests. Fed Vice Chairman for Supervision Randal Quarles believes this will still maintain strong capital requirements. Yet, dissenting Fed Governor Lael Brainard believes it could reduce capital requirements for big banks. In short, it’s hard to tell whether this action increases or decreases the likelihood the company continues its aggressive buyback policy.
Stay on the Sidelines With Wells Fargo
Wells Fargo shares may look like a temping opportunity at today’s prices. But despite a high dividend yield, shares aren’t cheap relative to peers. The stock trades at a forward price-earnings (P/E) ratio of 10.1 By comparison, Bank of America (NYSE:BAC) trades for 9.2 times forward earnings. Citigroup (NYSE:C) trades for 7.7 times forward earnings.
As we don’t yet know whether the coronavirus will lead to an economic downturn, catching this potential falling knife may not be profitable. The best move? Wait and see. There could be a better opportunity down the road to enter a position.
Thomas Niel, contributor to InvestorPlace, has been writing single-stock analysis for web-based publications since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.