Stock of the Week
NYSE Symbol: WFC
Price as of 10/1: $41.49
It's the start of the start of the fourth quarter and what a run it has been. The major averages are having their best year since 1997, up over 18% for the year. The US bond aggregate and emerging markets are still under water for the year, but improving. It's hasn't been a great year to be diversified. Going forward, we're entering the best two quarters of the year. Technology is typically one of the best sectors in the fourth quarter, but the sector is already up 26%. One sector that has performed well and should continue to perform well are the banks. This week we'll highlight one of Warren Buffet's favorite stocks and his largest position. The stock of the week is Wells Fargo. Thanks to a recovery in the housing market and low interest rates, the banks are thriving once again. The financials earnings and cash flow continue to improve allowing for higher share buybacks and dividend hikes. Even with the improving fundamentals, the stock and many banks still trade for a little more than 10 times earnings. With the broader market trading for 14 to 16 times earnings, Wells Fargo and the financials look like a safe bet if the economy and the housing market continue to improve.
Wells Fargo, the biggest U.S. mortgage lender, said Friday its second-quarter profit surged 20 percent as it cut expenses. Net income rose to $5.27 billion from $4.40 billion a year earlier. On a per-share basis, earnings were 98 cents, beating the 93 cents forecast by Wall Street. Revenue edged up to $21.4 billion from $21.3 billion and exceeded Wall Street expectations. "Wells Fargo again demonstrated an ability to grow during a dynamic economic and interest-rate environment," the bank's chairman and CEO, John Stumpf, said in a statement. San Francisco-based Wells Fargo controls nearly a third of the U.S. mortgage market, and that has helped bolster its earnings in recent quarters. It funded $112 billion worth of mortgages, down from $131 billion in the second quarter of 2012. With interest rates on mortgages rising sharply in recent weeks, analysts are concerned about the potential impact on the bank's mortgage business. Much of its recent lending came from refinancing, which has been reduced by the recent spike in rates. Mortgage rates jumped late last month from near-record lows and added thousands of dollars to the cost of buying a home, after the Federal Reserve signaled that it could slow its bond purchases later this year. The average rate on the 30-year fixed loan rose this week to 4.51 percent, the highest in two years. In the short run, higher rates appear to be drawing potential home buyers off the sideline. Buyers want to get a mortgage before rates rise further from their historically low levels. In the long run, more expensive home loans might slow the housing market's recovery, which has helped drive the U.S. economy. At the same time, higher loan rates would allow banks to make more from mortgage lending. J.P. Morgan CEO Jamie Dimon told CNBC Friday morning that Wells Fargo does "a lot better in the mortgage business than us. They have been doing better for a long time."
Currently, Wells Fargo trades for 10.3 times earnings, 2.5 times sales and boasts a dividend yield of 2.9%. The bank boosted their dividend 20% this spring with plenty of room to raise it further in the future. The current cash payout ratio is only 27%. Government regulations are improving getting less restrictive. In a hot market like this, many other stocks and sectors may outperform, but the financials and Wells Fargo are a good bet for an improving economy and a higher interest rate environment particularly if the housing market holds up.