Banks have been one of the worst sectors in the stock market this year. And even out of that struggling group, Wells Fargo (NYSE:WFC) has managed to stand out in all the wrong ways. Although it has bounced somewhat over the past month, Wells Fargo is still down a shocking 53% year-to-date.
The reasons for this woeful performance are numerous. Famed investor Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) has been dumping its position in Wells. In addition to that, Wells Fargo retains a damaged reputation as a result of its fraudulent accounts scandals. Even after bringing in a highly credible new chief executive officer (CEO), analysts are unconvinced that Wells Fargo can turn things around.
The operating results haven’t been perfect either. Wells Fargo already saw its earnings slip as it has dealt with huge costs associated with its scandals. Now, thanks to the novel coronavirus, it has had to suspend the share buybacks while provisioning more capital for potential loan losses. With all this terrible news, why then am I still optimistic? Read on.
Navigating the Pandemic
Wells Fargo’s Q3 results, which came out in October, were a mixed bag. Earnings per share fell just short of expectations. However, the company’s revenues came in far ahead of what folks were anticipating. This split result should show the underlying cross-currents involved here.
As far as the economic crisis goes, it’s not having nearly as bad an impact as analysts had feared. Wells Fargo provisioned just $769 million for additional loan losses this quarter, which is a drop in the bucket for a bank that holds several trillion in assets. Analysts, by contrast, had forecast more than double that level of provisioning this quarter.
The main banking franchise hasn’t gone anywhere either. Wells Fargo still cares for $2 trillion in assets and serves roughly 70 million consumers and small businesses. While the bank has suffered a great deal of negative headlines, looking at its trends in terms of deposits and numbers of accounts that it holds, there has been no meaningful defection away from the bank. As such, with the main business still steady and the pandemic not hitting the bank nearly as hard in terms of credit risk as anticipated, things will get back to normal in due time. And for Wells, normal is quite a good thing indeed.
Wells Fargo Has Tremendous Core Earnings
Right now, everything is noisy with all the pandemic and elevated legal costs. However, it’s worth remembering what Wells Fargo looks like in a normal economy. Here are the bank’s earnings per share over the past five years:
- 2015: $4.12
- 2016: $3.99
- 2017: $4.10
- 2018: $4.28
- 2019: $4.05
Obviously, earnings aren’t going to be anything like that in 2020 or 2021. At this time, analysts see the bank getting back above $3 in earnings for 2022 and then returning to normal after that. So, for investors that are patient, at $25, Wells Fargo is trading for just 6x its usual $4.10 or so in annual earnings. But there will be a couple of years of waiting to get to that point.
That said, the $4.10 figure might understate things a bit. Prior to the pandemic, given Wells Fargo’s tremendous profitability and excess cash flow, management was planning to buy back up to 10% of the firm’s outstanding stock every year. Needless to say, your earnings are going to shoot up when you retire stock that quickly.
On top of that, Wells Fargo is spending billions on extra legal and compliance costs. Its efficiency ratio, which measures a bank’s overhead, is far worse than almost all of the other national banks. Ironing out these extra costs over the next few years should add back another dollar or more of earnings per share per year. Add it all up, and the bank should be able to produce $5 of annual earnings per share, and perhaps even more, by 2024. Needless to say, $25 is a fantastic price for that level of earnings.
The Bottom Line on WFC Stock
I’m not afraid to admit that I’ve been early in recommending Wells Fargo previously. And, in investing, if you’re early, you’re wrong. Owning Wells Fargo has not been a pleasant experience this year, that’s for sure. But for all the grief that Wells Fargo has gone through in 2020, the actual underlying business hasn’t meaningfully deteriorated.
The company’s advantages, including an unmatched national deposit base and enviable branch network remain intact. Additionally, even with the company’s costs bloated due to its numerous legal issues, Wells Fargo is still reporting decent enough operating results. The sky isn’t falling by any means.
Now the market is starting to wake up to that fact. The quick 20% move up in Wells Fargo off the lows could be just the beginning. With value stocks on the move, there could a lot more in the tank. Further to that, the tax loss selling that has plagued Wells and other bank stocks is just about concluded as well as the year draws to a close. All in all, numerous tailwinds are lining up for Wells Fargo, and shares could surge into the $30s within the next few months.
On the date of publication, Ian Bezek held a long position in BRK.B and WFC.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.