Is Wells Fargo a Buy Ahead of Earnings?

Wells Fargo (NYSE:WFC) emerged from the financial crisis relatively unscathed. As the country’s largest mortgage originator, it has benefitted from the rebounding housing market in the past year; however, some investors and analysts worry that since home loan growth is losing steam and interest rates remain low, Wells Fargo will be unable to maintain its growth. Only time will tell, as the bank is scheduled to report its second quarter earnings this Friday. Let’s use our CHEAT SHEET investing framework to decide whether Wells Fargo is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Movement

Friday’s earnings announcement is huge for Wells Fargo. Investors and analysts were skeptical of the bank’s first quarter earnings report because its mortgage origination business appeared to be losing steam. Around 65 percent of mortgage applications were for refinancing purposes, down 76 percent in the previous year’s quarter. That percentage is likely to decrease further as long-term interest rates begin to rise again; however; as refinancing has tapered off, the housing market has hit its stride again. The bank will be able to generate more new home loans to buyers as demand increases and will be able to write down more loans on its balance sheet as housing prices appreciate.

E = Earnings Are Increasing Year-over-Year

Wells Fargo has demonstrated strong earnings per share growth over the last five quarters. In the most recent quarter, the bank reported earnings per share of $0.94, higher than analysts’ estimates of $0.88. Despite beating estimates and reporting another quarter of earnings growth, the market reacted adversely to the report, because the mortgage origination business showed slowing growth and Wells’ net interest margin decreased yet again to $3.48. New home loan applications decreased by around 9 percent—a relatively large number when you consider that mortgage originations make up around a third of the bank’s business.

The third row of the table shows Wells Fargo’s net interest margin—the difference between the interest the bank pays to depositors versus the interest it collects on loans. Wells Fargo’s profitability is greatly influenced by how large or small the NIM is. The steady contraction of this margin, shown in the table below, is a red flag for the bank’s future profitability. Looking at the attractive growth in the table below, its difficult to imagine Wells Fargo’s growth taking a substantial hit; however if both net interest margins and mortgage originations continue to fall, this will most certainly be the case.

2013 Q1 2012 Q4 2012 Q3 2012 Q2 2012 Q1
EPS Growth YoY 22.67% 24.41% 22.22% 17.14% 11.94%
Rev. Growth YoY -1.74% 6.52% 8.08% 4.43% 6.43%
Net Interest Margin 3.48% 3.56% 3.66% 3.91% $3.91

*Data sourced from YCharts

S = Support is Provided by Institutional Investors

Wells Fargo has enjoyed longtime support from legendary investor Warren Buffett. His company, Berkshire Hathaway (BRK.A & BRK.B), added 18 million shares last quarter, bringing its total position in the bank to 458,170,323—working out to roughly 20 percent of his portfolio. Wells Fargo is the largest holding in Berkshire’s portfolio. Its never a bad thing to have the Oracle of Omaha on your side.

E = Exceptional Performance Relative to Its Peers

While Wells Fargo trades at a higher forward price to earnings multiple than its chief competitors—Citigroup (NYSE:C), Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM), and Goldman Sachs (NYSE:GS)—it maintains the highest return on equity of the five megabanks and the highest dividend yield at 2.9%. Wells Fargo is more expensive relative to the rest of the banks because it engages in more straightforward banking operations and has less exposure to overseas risks and derivatives trading. Still, its price to equity multiple is cheap compared to the industry and the S&P 500 average. Wells Fargo just announced a dividend increase from $0.25 to $0.30 and, with a payout ratio of 26 percent, it has room to increase this dividend in the future.

WFC C BAC JPM GS
Forward P/E 10.88 9.16 10.19 9.13 10.13
ROE 13.07% 4.65% 2.14% 11.55% 10.12%
Dividend Yield 2.90% 0.10% 0.30% 2.80% 1.30%

*Data sourced from Yahoo! Finance

T = Technicals Are Strong on the Chart

At the end of Tuesday’s trading day, Wells Fargo traded at $42.69, above both its 200-day moving average of $37.39 and its 50-day moving average of $40.78. The bank has experienced a definitive uptrend and is up almost 30 percent in the past 12 months. Additionally, it recently hit a 52-week high of $42.97 on Monday. Wells Fargo could see a new 52-week high depending how its earnings announcement is received this Friday.

 

Conclusion

Despite slowing growth in mortgage refinancing and a compressed net interest margin, Wells Fargo will continue to earn steady earnings in the coming quarters. Compared with its peers, Wells is slightly more expensive, but relies less on revenues from riskier areas of banking, such as derivatives trading and international banking. The company pays out an attractive dividend, which has increased twice in the past several years. Additionally, the stock’s technicals are very strong. If you are looking for a relatively low-risk player in the banking sector, Wells Fargo is an OUTPERFORM.

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