The Wells Fargo Sell-Off Is Overdone: Buy Buy Buy!
The news on Wells Fargo & Co (WFC) has been nothing but negative since the sales scandal was revealed. While the immediate financial hit ($185 million) is pocket change for Wells Fargo, qualitative factors are driving the stock down.
The shares have fallen 11% since the news of the scandal broke. Neither the exit of long-time CEO John Stumpf (without a golden parachute) nor good quarterly earnings have had a positive impact.
The negative bias is not without reason of course.
Since the scandal broke, U.S. states and public investment funds have sought to end business ties with Wells Fargo, at least temporarily.
A single action such as this will not make a material, dent but the fear here is of contagion (i.e. that others may follow Ohio's lead and the cumulative effect will be very negative for earnings).
This does not even begin to consider the effect the scandal might have on choices made by retail customers which are Wells Fargo's bread and butter.
Considering all the negativity and challenges Wells Fargo is likely to face, why should you buy the bank now? The chart below shows no reason to step in at this time. It's on a decidedly negative trajectory and well below the 200-day moving average.
However, there are 3 reasons I think investors ought to consider buying the stock now.
- A 3.40% yield. Wells Fargo stock represents a yield twice that of the 10-year U.S. treasury bond, 1% more than the 30-year U.S. treasury bond, and higher than all it's peers like JPMorgan Chase & Co (JPM), Citigroup Inc (C), and Bank of America Corp (BAC). Plus, the dividend isn't in danger of being cut as the payout ratio is only 37%. Sure, we may not see the 9% to 10% growth in dividends of the recent past, but a decline is far from probable.
- Fundamentally undervalued at 1.3 times book value. I use a short-hand method of deriving what the fundamental price to book value ought to be for a bank in gauging whether it is or is not undervalued. The formula divides the difference between the expected return on equity and the growth rates by the difference of the cost of equity and the growth rate. That model suggests that Wells Fargo ought to be trading at a price to book value of 1.5 times, or 13% above its current valuation.
- An overly negative market. Interestingly, we can reverse engineer the above calculation to see what kind of growth the market is expecting from Wells Fargo in the long-term by plugging in the current market multiple and solving for x. The model tells us that the market thinks the bank will grow at 5.9%. The only time the bank's net income grew at a comparable pace was in 2008 when it looked like the financial world would collapse. We will no doubt see a lot of earnings volatility in the short-term, but in the long-run, the bank will be fine. After all, we know for a fact that the fraudulent bank accounts added next to nothing to its bottom (or top) line. Putting in controls to prevent such activity will not hamper growth.