On Oct. 14, Wells Fargo (NYSE:WFC) reported that it has become profitable again. As a result, WFC stock is now worth considerably more than it was previously. In my last article on the company, published on Sept. 23. I wrote that the shares were meaningfully undervalued.
Wells Fargo reported third-quarter net income of $2.04 billion versus a loss of $2.38 billion last quarter. Moreover, its diluted earnings per share came in at 42 cents, versus -66 cents in Q2.
That must be a relief for the owners of WFC stock. That’s especially true, since the bank had to cut its quarterly dividend in July from 51 cents per quarter to 10 cents. That means that the stock now has a yield of 1.65%, versus its prior dividend yield of well over 6%.
Growing Dividends and Tangible Book Value
Wells’ return to profits might eventually allow the bank to increase its dividend. But even more importantly, the increase in the bank’s net income will allow it to automatically raise its tangible book value.
As I wrote in Sept., Wells Fargo’s tangible book value per share (TBVPS) was $31.88 on June 30. But as of Sept. 30, that had increased about 1% to $32.23 per share, as shown on page 16 of its earnings release.
Tangible book value is what a bank is worth after deducting all of its liabilities and excluding its intangible assets. So the metric theoretically represents the bank’s bare-bones net worth.
That is important for two reasons. First, it means that WFC stock is now selling well below the bank’s TBVPS. For example, at just under $22, WFC stock trades for just 68% of its TBVPS.
Bank stocks often sell for 50% to 100% more than their tangible book value. That means that WFC stock could rise substantially higher, especially once the market begins to like the stock again.
Return on Tangible Book Value
But TBVPS is also important because we can use it to calculate the bank’s return on tangible book value. For example, last quarter the bank earned 42 cents per share or an annualized $1.68. Therefore, its expected return on TBVPS is 5.2% (i.e., $1.68 divided by its TBVPS of $32.23).
But wait, there’s more. Since investors can now buy WFC stock at a discount to its TBVPS, they have a higher return on TBVPS. Their return is 6.9% (i.e., $1.68 divided by the stock’s current price of $24.23), versus the 5.2% return on TBVPS as of last quarter.
However, if WFC stock were to rise to one-third above its tangible book value over the next several years, investors’ return would be even higher. For example, 1.333 times the bank’s tangible book value is $42.96 per share. Therefore, the expected return would be 96%.
Here is how that could happen. Let’s assume by the end of 2022, the bank’s average return on equity is 5.2%. That would put its TBVPS 12% higher than now at $36.10. If WFC stock trades just 20% above that level, it would be worth $43.32 per share.
Therefore, in two years WFC stock could easily be more than 80% above today’s price. Over 2.25 years, in that scenario its average annual return will be 35.4% annually.
What To Do With WFC Stock
Analysts agree with me that WFC stock is worth substantially more than its current levels. For example, Marketbeat.com reports that 24 analysts have an average price target of $31.48 on the stock.
Moreover, Yahoo! Finance says that 24 analysts have an average price of $29.59 per share. Lastly, TipRanks.com states that the mean price target of 13 analysts it surveyed is $28.60,.
Therefore analysts think the shares are worth between $28.60 and $31.48, or 18% to 40% higher above their current level.
The bank should continue to heal, causing both its net income and its tangible book value per share to rise. As analysts begin to incorporate these gains into their models, WFC stock could double within the next two years. That’s a very decent ROI for most investors.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.