Wells Fargo (NYSE:WFC) reported excellent earnings on Oct. 14 for its quarter ending Sept. 30. Net income rose 59.2% over last year. But more importantly, the bank stepped up its share buyback program. It repurchased $5.3 billion of WFC stock during the third quarter.
This was significantly higher than the prior quarter. As a direct result, investors can expect to see the shares rise significantly over the coming year.
Moreover, the buyback program will have other major benefits for WFC stock.
One direct result of this is buyback program is that it has led to higher earnings per share (EPS) growth compared to its net income growth. For example, EPS rose from 70 cents per share to $1.17. That is a gain of 67%.
This is higher than the 59.2% increase in net income, going from $3.216 billion to $5.122 billion year over year. That’s a result of Wells Fargo begining significant share buybacks, reducing the share count.
Benefits of the Share Buyback Program
Let’s assume that Wells Fargo decides to continue to buy back $5.3 billion of its shares each quarter. That works out to $21.2 billion annually and represents 11.1% of its $191.56 billion market value as of Oct. 14. That is a huge buyback yield.
At that rate, over three years, at least one-third of the shares would be cut from its share count. Here is why that is important.
First, as I mentioned above, the EPS automatically rises higher than it would be without the buybacks. That allows the stock to rise, assuming the same price-to-earnings ratio is kept with higher net income. The reason is the denominator is lower in the net income/shares outstanding calculation of EPS.
Second, the bank will be able to increase its dividend per share faster than it would otherwise. The reason is that with the lower share count, even if they spend the same amount on dividends, they will automatically raise the dividend per share (DPS).
On top of that, Wells Fargo tends to raise its dividend cost each year. So the buybacks will act to accelerate the DPS growth rate.
Third, the book value per share and the tangible book value per share (TBVPS) will grow faster than otherwise. For example, right now Wells Fargo now has a TBVPS of $35.54 as of Sept. 30, 2021. But a year ago it was at $32.15, representing an increase of 10.54%. This can be seen on page 3 of the bank’s supplemental information slide deck. But this is much faster than the growth in tangible common equity.
For example, on that same page 3 you can see that in September 2020, the tangible common equity was at $132.874 billion. As of September 2021, it had grown to $142.047 billion. That is a growth rate of just 6.9%. So the per share growth (i.e. TBVPS) was 10.54% compared to just 6.9% in the underlying dollar growth. This is a direct benefit from the share buyback program.
This matters since the market generally puts a fairly stable multiple on TBVPS. Right now it is just 1.27 (i.e., $45.27 price as of Oct. 14 divided by $35.54 TBVPS). Therefore, even if common tangible equity stays level over the next three years (maybe due to write-downs), the TBVPS could rise at least 33% from buybacks. That will push WFC stock 33% higher at the same P/TPBVPS multiple.
Where This Leaves WFC Stock
Investors should not take this huge gain in its share buyback program lightly. I think this clearly makes WFC stock a value buy. And it doesn’t hurt that the bank just increased its dividend to 20 cents quarterly or 80 cents annually. That gives it a dividend yield of 1.78% on annual basis. I wrote in August that given its dividend gains, WFC stock is worth at least $60 per share.
So, if you add in its annualized buyback yield of 11.1% (see above) to the 1.78% dividend yield, the total yield is now 12.88%. Keep in mind that the buyback and dividend yield fall as the share price rises. So even with an assumed 11% total yield over the next year, shareholders will be better off. That makes WFC stock one of the most undervalued total yield stocks in the market.
On the date of publication, Mark R. Hake did not hold a position, directly or indirectly, in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.