Wells Fargo (NYSE:WFC) is a tremendous bargain today. Wells Fargo stock, which was trading at $26.30 this afternoon, is selling for just 80% of its tangible book value per share (TBVPS) of $32.90.
To put it succinctly, that valuation is simply too low. Let’s assume the very worst happens: somehow Wells Fargo will have to write off so many loans that its book value falls to its present stock price.
First of all, that suggests that loans worth 17.3% of the whole company’s shareholder value will be written off. Since its book value is now $182.7 billion, under that scenario, $31.5 billion of loans will go under. That means that the bank will have to assume that the loans will never be repaid and write them off as charge-offs. That seems almost impossible.
Even during the financial crisis in 2008, Wells Fargo’s book value did not decline. It actually increased from 2007 to 2008 and through 2009. So contemplating a 17.3% decline in the bank’s book value seems almost absurd. But that is how the stock market is pricing WFC stock today.
Another reason why the price today seems out of whack is that even in the last recession, the bank’s stock price got down to about $12 per share. But its book value was $16.09 per share, according to Value Line Research.
Wells Fargo stock did not change hands for 75% of the bank’s book value for very long. When the economy started to improve, it quickly shot up to 100% of book value per share and then rose further.
The economy is now starting to improve. The bank’s stock price should soon start to reflect that reality. Based on Wells Fargo’s present TBVPS of $32.09, the stock looks poised to gain about 22%.
The Bank’s Dividend Yield Implies a Potential Gain of 41%
Wells Fargo pays an annual dividend of $2.04 per share. On April 28, it declared a quarterly dividend of 51 cents per share. Its dividend yield stands at 7.5%.
But the company has not decided to cut its dividend. It has made no mention of doing so, even though it suspended its share buybacks.
Analysts, on average, expect its earnings per share to come in at $1.43 this year. But that includes a whopping $3 billion reserve hit (equivalent to almost 73 cents per share) to the bank’s earnings. However, if the bank does not take such a hit, it will have enough funds to cover its dividend. Its EPS for 2021 is expected to be $2.58, according to Seeking Alpha. So it will be able to cover its dividend next year.
Therefore, I don’t believe the bank will cut its dividend this quarter. Even if it does, I doubt whether its dividend will stay below its current level for very long.
Therefore, based on Wells Fargo’s historical dividend yield, at what price should the stock be trading? According to Seeking Alpha, its average dividend yield in the past four years was 3.49%.
That indicates that the stock should be trading at $58.45 (i.e. $2.04 divided by 3.49%), not $26.30. But let’s assume that the stock’s current yield should be 50% higher than its historical level. After all, the economy will undergo a U-shaped recovery, and it will take awhile before the stock recovers.
That implies the dividend yield now should be 5.5% or so (halfway between 3.5% and 7.5%). That means the stock should be at least $37 per share. That represents a gain of 41%.
Merging the Two Implied Values for Wells Fargo Stock
As we have seen, the true value for Wells’ stock, based on its book value per share, should be $32.09. That’s about 22% above today’s price.
Using a modified historical dividend yield approach, the stock is worth $37 per share, a gain of 41%.
The average of these two target prices is $34.55 per share. So look for the shares to gain 31% over the next year or even earlier.
One positive catalyst for the shares could be the June release of the company’s stress tests by the Federal Reserve. I wrote about that in my earlier article, which was published last month. I don’t believe the Federal Reserve is going to force the bank to cut its dividend to preserve capital.
Therefore, Wells Fargo stock seems to provide conservative investors with a large margin of safety. That’s especially true now because it sells for such a huge discount to its tangible book value.