Wells Fargo Still a Buy Despite Wednesday’s Rally

Better than expected second quarter earnings news from California-based Wells Fargo (WFC) and its unexpected ten percent dividend boost helped spark a hefty rally in the overall market—particularly beleaguered financials—on Wednesday. While the bank’s net income fell 21% in the quarter, this was better than forecast. Also, the bank was able to increase its net interest margin to 4.92% from 4.89% from the year-ago period. This is a pretty impressive accomplishment in a brutal market for financials. Furthermore, WFC is headquartered in “ground zero” for real-estate troubles - California.

While the market—desperately looking for a reason to rally—widely celebrated Wells Fargo’s news and even the dividend increase, some analysts griped that it was not a smart move in the current environment. For one thing, WFC’s dividend already is over six percent and—unlike many of its peers—appears secure at this level. Second, with so many competitors struggling mightily, WFC might have been wise to put this cash to work on the acquisition front. Money is tight right now and many analysts seem to believe that WFC would be better hording every penny rather than returning any more to shareholders in the form of higher dividends.

WFC’s solid second quarter comes as a reminder at an opportune moment. By Tuesday, the market was trading as if every bank in the U.S. was on the road to insolvency. Wells Fargo served to remind all that, even in the battered California market, not every bank is on the ropes. It was a most propitious time for a little good news to put things into perspective. There are many tough months ahead for the U.S. financial system and there will be more bad news before all is said and done. Indeed, before this difficulty is behind us, some of the stocks that looked on their way to zero on Tuesday may well end up there. However, the financial system will survive this turmoil and likely emerge stronger and wiser in the future.

While Ockham prefers not to play the game of calling market bottoms, we do get a sense that we may be quite near one at least in the financials sector of the U.S. market. The doom and gloom in this sector is so profound that it is palpable, and photos of elderly depositors lining up under tents at IndyMac (IMB) branches in California earlier this week only add to the environment of despair. If one adheres to the adage that the time to buy is “when there is blood on the streets,” then we are getting some glimpses of blood.

Banks like Wells Fargo and J.P. Morgan (JPM) have been well managed through all of this and do not deserve to be trading at such depressed levels, despite the challenging environment. Despite Wednesday’s nearly thirty percent rally, WFC’s stock is still fairly attractively valued to us. Using our valuation metrics as of Wednesday’s close, WFC is still a Buy. The stock's historic price-to-cash flow range is 12.7 – 16.6 and the stock currently trades at a multiple of 11.9X. The price-to-sales range is 2.2 – 2.9 and the stock is trading at 2.05x. Even at the low end of its historic range, WFC merits a price close to thirty.

Wells Fargo and J.P. Morgan’s better-than-expected earnings news may, in time, prove to be the nadir for financial stocks. Markets are discounting mechanisms and will anticipate future developments well in advance of reality. The troubles bedeviling financial companies are by no means behind us. Indeed, there will be many mergers of desperation and bankruptcies before the smoke clears. Five years from now, there will be fewer institutions than we have today and those that survive will be run far more conservatively than what we have seen in the past decade. However, the sun will still rise in the morning and the U.S. financial system, the dollar and the economy as a whole, will rebound in time.

Comments

[User 169185]

What planet are you on?

[alikhan]

I think he's right on the money. Trying to catch a falling knife is difficult and dangerous, but what Ockham is saying is that the entire financial sector got beat like they stole something - even the companies that didn't deserve it. And Wells Fargo has been a premium player throughout this mess. If you're going to buy WFC, make sure its a really long term play, given the 30% increase yesterday.