InvestorPlace’s Luke Lango didn’t pull any punches in his most recent article about Wells Fargo (NYSE:WFC). Luke called the bank’s earnings ugly. Yet, my colleague still feels Wells Fargo stock is undervalued.
I’m not nearly as convinced. Here’s why.
There Are Better Options Than Wells Fargo Stock
When I’m asked to cover a stock, before I determine whether it’s a buy, sell, or something to watch, I consider possible alternatives. I don’t have to buy this or that bank stock. I could buy something else like BlackRock (NYSE:BLK) for my financial services exposure. BlackRock just had boffo earnings. And I’ve always admired Larry Fink, BlackRock’s chief executive officer.
But for a second, let’s assume that I must buy one bank stock. What are my alternatives?
In early June, I suggested that investors look elsewhere if dividends weren’t a priority. Now that Wells Fargo has cut its quarterly dividend to 10 cents, producing an average yield of 1.6%, those buying its stock have to be patient because the issues that plague the bank aren’t going to magically disappear.
So, if you’re a dividend investor, the question you have to ask yourself is whether you think Wells Fargo can get its dividend back up to 51 cents in a reasonable amount of time. How long is reasonable? Everyone’s different, but I’d say 12 to 18 months.
Therefore, if you believe that Wells Fargo CEO Charlie Scharf is the person to right the ship, the question then becomes whether there’s enough reward available for the risk you’ll be taking.
Think about it. KBWB currently has an SEC 30-day yield of 4.19%, more than double Wells Fargo’s current yield. You could hold this until the bank gets its dividend back into the 51-cent range.
Let’s Consider Its Valuation
My colleague isn’t the only one who believes Wells Fargo stock is undervalued. Evercore ISI analyst John Pancari recently raised his rating from “in-line” to “outperform” with a $27 target price. That’s 10% appreciation potential over the next 12 months.
“Fundamentals remain particularly pressured at WFC, but we are encouraged by management’s decisive actions on capital and credit, and an emerging commitment to tackle Wells’ lagging returns via expense efficiencies,” Pancari wrote in a note to clients. “The battle is likely to be a long one and revenue headwinds remain a lingering factor, but we believe the tide is turning on Wells fundamentals.”
Pancari sees the dividend cut as a responsible move by management to get its expenses in line while it works on rebuilding its various revenue streams. He also believes that the bank’s moves to increase its credit reserves make sense given the novel coronavirus has taken a big bite out of the economy.
For all these moves, WFC is trading at 11.3 times its 2021 earnings estimate of $2.17 a share. My colleague sees 2021 earnings around $3 a share. At its historical norm of 12 times forward earnings, it’s got almost 50% upside over the next 12 months.
Clearly, WFC is cheaper than it’s been in some time. So, I get the valuation argument. However, if the economy doesn’t cooperate, I could easily see WFC fall into the teens. At the moment, the economy could go either way.
The Bottom Line on Wells Fargo
I’m not sure I’d be buying any bank stocks in the current scenario that America finds itself. Add to this a bank culture that Scharf’s in the process of fixing and you’ve still got some serious question marks.
If it were me, I’d take half the amount I wanted to commit to WFC and allocate this to KBWB instead. You might not make as much should it jump 50% in the next 12 months, but you won’t lose as much if Wells Fargo fails to deliver, which is in the realm of possibility.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.