Should Investors Buy Wells Fargo on This Pullback?

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September 16, 2016 7:06am NYSE:WFC

From Bob Ciura: In this low-interest-rate world, income is hard to come by. Bonds yield relatively little, and savings vehicles like certificates of deposit yield even less. This has compelled many investors to buy dividend stocks, and for good reason.


The S&P 500 Index on average yields about 2%. But investors can get even higher dividend yields from some blue-chip industry leaders. Wells Fargo stock has declined recently because of a hefty fine, as the negative headlines about the banking giant are spooking investors.

The good news is that Wells Fargo & Co (NYSE:WFC) has built a strong brand and a leadership position in the banking industry. It will come through this rough patch relatively unscathed with time. Investors may need to be patient and endure the short-term volatility, but Wells Fargo is still a highly profitable company with a solid 3.2% dividend yield.

Short-Term Panic Over Wells Fargo Stock

Wells Fargo stock was already having a difficult year, due to a difficult business climate for banking marked by historically low interest rates, and the recent news has only clouded Wells Fargo’s near-term outlook.

The stock has lost 14% of its value year-to-date, and 12% over the past one year. It has significantly underperformed the market for an extended period. The S&P 500 has delivered a 9% return over the past one year.

The sell-off in Wells Fargo shares gained steam in recent periods. The stock is down 6% just in the past one week, because the company got hit with a $185 million fine pertaining to charges that it illegally set up accounts for customers without consent.

And, the U.S. Department of Justice has announced it will open an investigation into the matter.

All of this makes for pronounced headline risk for Wells Fargo stock, which may continue to experience downside as a result. Investors should expect continued volatility, but while Wells Fargo is currently under a media firestorm, it remains a top bank stock for the long term.

Wells Fargo is the third-largest U.S. bank by assets and is the largest mortgage originator in the country. It has a very large business that can withstand the current challenges.

Last year, revenue and net profit totaled $86 billion and $23 billion, respectively. From that perspective, the fine should not have a lasting impact on Wells Fargo.

To be sure, headline risk is not the only risk facing Wells Fargo. A key factor holding Wells Fargo back is low interest rates. Since the 2008 financial crisis and recession, the Federal Reserve lowered interest rates to zero, to try to boost the economy.

Today, there is an ongoing debate over whether the Fed should hike interest rates, as the economic recovery remains firm.

Low rates hurt banks because it makes it harder to increase profits on the interest spread between loans and deposits. Banks want higher interest rates because it widens net interest margin.

Wells Fargo is off to a good start this year, given the persistence of low interest rates, which weigh on its bottom line. Revenue increased 4% last quarter to $22.16 billion, due to growth in both loans and deposits. Loans were up 9% last quarter, while deposits rose 4%.

Earnings per share declined 2%, due to a 4% year-over-year drop in net interest margin, but the company remained strongly profitable with $1.01 per share in earnings.

Going forward, higher interest rates are a matter of when, not if. It may not take place in 2016, but another Fed hike is coming, and the long-term trajectory of rates is very likely up.

Higher interest rates, along with the continued improvement in the U.S. economy, should provide a sustained tailwind for Wells Fargo.

Attractive Dividend, Valuation

The good news from all this is that investors can use the dip in price of Wells Fargo stock as a buying opportunity.

Based on its current share price, Wells Fargo stock is valued for 11 times its anticipated earnings per share over the next one year. Wells Fargo stock is cheaper than the S&P 500 in terms of forward price-to-earnings.

In addition, Wells Fargo has a 3.2% current dividend yield, about 100 basis points higher than the average stock in the S&P 500.

As a result, Wells Fargo stock is an attractive pick for value and income investors alike.

This article is brought to you courtesy of Wyatt Research.


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