Stock of the Week
NYSE Symbol: WFC
Price as of 2/25: $32.40
The averages started a correction this week due to social unrest in the Middle East and a spike in the price of crude oil. The question now is how long will the correction last? The markets in my opinion were long overdue for a pull back and unfortunately when they do sell off it's never on good news. With the correction in progress, now is a good time to make a list of stocks you want to buy on pullbacks. The recent spike in oil hasn't hurt all sectors. Most energy related stocks have actually improved in particular the oil drillers and alternative energy stocks like Canadian oil sands plays like Suncor Energy. The financials have also held up well as the day draws closer to when the government will allow them to hike their dividends once again. This week we'll feature a large cap financial that has received insider buying from a number of large hedge funds in the last quarter. The stock of the week is Wells Fargo. Wells Fargo serves one-third of the nation's households, 10 percent of the small businesses in our country and 70 percent of the fortune 500. The stock has performed great since we last featured it, but that hasn't stopped top hedge fund managers like David Tepper from adding to his position in Wells Fargo. Warren Buffett added to his stake in Wells Fargo by 1.8% or 6.2 million shares upping his sizable position to $11 billion. Top mutual fund managers like Bill Miller count Wells Fargo as one of their top positions. Even though the financials are acting better, the top minds of Wall Street are still buying the sector ahead of dividend hikes and a continued improving environment for the financial industry.
Wells Fargo, the fourth largest bank in the U.S. by assets and the second largest bank by market cap, reported in-line earnings of $3.4 billion or 61 cents per share back in January helped by an improving loan portfolio and withdrawals from its capital reserves by $850 million. Revenue fell 6.4% to $21.5 billion. All three of Wells Fargo's larger competitors saw their assets fall in the fourth quarter, however, Wells' assets rose 3 percent. For the full year, Wells Fargo reported net income of $12.36 billion compared with $12.28 billion in 2009. The solid earnings are due to a well diversified portfolio of improving mortgage business, a strong asset management division and improving environments for the brokerage and securities & trading divisions.
Looking forward, the financial landscape will only improve. When interest rates eventually rise, the banks will benefit from interest rate spreads between lending and borrowing. Right now, Wells Fargo's net interest spread is about 4%, though that could rise to 5% or 6% in a firmer economy, if history is any guide. Second, Wells Fargo has performed well even as the housing sector remains dormant. As housing eventually rebounds, Wells' mortgage origination business should once again become a profit machine. Wells Fargo has $40 billion of financial firepower sitting unused as lending remains slow in this economy. Once the bank steps up its lending, that $40 billion can earn far higher returns. Add all this up and analysts see a bright future for Wells Fargo. The analyst at Guggenheim Securities think "normalized earnings," which the bank may generate within a few years, could hit $4.25 a share without adding any incremental business.
The other catalyst coming down the road is a dividend hike. The Federal Reserve must first complete a second round of bank stress tests, whose results are expected in March. JP Morgan may be the first big bank to hike their dividend from 20 cents to a dollar a share. Wells Fargo should be right behind them. The analyst at Sterne Agee thinks the payout ratio may eventually rebound to 30% of earnings or $1.08 dividend based on 2012 profit forecasts. This would push the yield above 3%. As the economy improves, the dividend could move even higher, creating the impetus for a dividend yield above 4% when measured against today's stock price.
Even with these improving fundamentals, Wells Fargo's stock remains compelling. Currently the stock trades for less than 10 times next years' earnings, 2 times sales, and 1.4 times book value. The financials are one of the few sectors not to fully participate in this bull market yet with fundamentals that should continue to improve over the coming years.