There is no shortage of risks to ‘big bank’ plays like Wells Fargo (NYSE:WFC) stock. Yet in recent weeks investors have been willing to take on those risks.
WFC stock, in fact, has gained 32% in the last month. Other financials too have rallied nicely. To be fair, there is some logic to those rallies, even with the concerns facing the sector.
But I’m not close to convinced that there’s logic behind the rally in Wells Fargo stock. Investors seem to be bringing WFC along for the sector’s ride, without fully appreciating the significant, ongoing problems specific to Wells Fargo.
Put another way, there are reasons to be skeptical toward the bank rally of late. There are even more reasons to be skeptical of WFC stock itself.
The Plunge in Bank Stocks
2020 has not been kind to bank stocks. Big bank peers haven’t fallen nearly as far as WFC has, but most bank stocks still are down double-digits in percentage terms.
Obviously, the novel coronavirus pandemic is a factor — but it’s not necessarily a direct factor. Investors in this market have been content to look past near-term pressures to better days in the future.
The worry for banks, and particularly big banks, is that those better days might not arrive. Long-term interest rate expectations had started to come up a bit before the pandemic. But the Federal Reserve is going to keep its short-term rates near or at zero for years to come.
That in turn pressures net interest margin, or the spread between what a bank pays depositors and gets paid by lenders. Lower NIM means lower profits, even ignoring the significant but so-far manageable credit losses driven by economic disruption.
The pandemic has had another substantial, if indirect, impact. The myriad disruptors coming for big banks like Wells Fargo are seeing accelerating adoption amid the pandemic. And so payment platforms are winning, and potentially taking market share. Nonbank lenders can do the same. Even the traditional, and profitable, initial public offering faces competition from suddenly profitable SPACs (special purpose acquisition companies).
There’s a “double whammy” effect, then. Younger, more nimble, rivals are coming for the big banks’ business. What business those big banks, including Wells Fargo, looks like it will be less profitable. Even ignoring the near-term impacts of the pandemic, it’s not a surprise that the group, including WFC stock, has sold off so sharply since March.
Big Banks Rally
But, again, bank stocks have rallied, including a nice upward turn for WFC stock. Admittedly, the group did, and still does, look enticing.
For one, valuation has come in sharply. Relative to 2020 Wall Street consensus earnings of 34 cents, WFC stock hardly looks cheap. Even 2021 estimates near $2 suggest a reasonable, but not necessarily spectacular, fundamental case.
But those earnings obviously are somewhat depressed, even looking to next year. Meanwhile, Wells Fargo stock now trades at a sharp discount to its book value just under $39 per share. Some investors have seen Wells Fargo and other big banks as simply too cheap.
Second, the short-term news has been better than feared. In many cases, the news actually is good. Credit card delinquencies, for instance, are at their lowest levels in at least three decades. The housing market is strong.
In a market where value seemingly is hard to find, investors have looked to find it in the financial sector. Those investors may not be wrong.
Why WFC Stock?
Admittedly, little of the analysis so far has focused on WFC stock itself. But that gets to the core point.
Big banks are facing real risks. There’s a case, particularly given year-to-date declines, to take on those risks. The question with WFC stock, however, is: why not choose another big bank? Or another bank of any size?
After all, other big banks haven’t underperformed for years. Wells Fargo has.
Other banks have cut their dividends. Few have slashed their payouts the way Wells Fargo did; its quarterly distribution went from 51 cents to 10 cents.
It’s not just the negative attributes that matter, either. Wells Fargo doesn’t have a strong business on which to hang its hat. The reputation of the consumer business has taken a beating. Wells isn’t a leader in investment banking. The company has been too busy putting out fires (and laying off workers) in recent years to drive real innovation.
So as far as the case for the sector goes, I see the logic. Investors who like that case, however, have many better choices than WFC stock.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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