Too Early and Risky to Bottom Fish for Wells Fargo

Some stock pickers like to try to pick the tops and bottoms of markets, and bottom fishing seems to be all the rage these days, especially when it comes to the banks, insurers and other financials. Anybody who has tried bottom fishing bank stocks since last fall is hurting unless they cut their losses short when bank stocks failed to rally from their depressed levels.

Last week was a disaster for bank stock bottom fishers. I've just done a review of eight articles and reports about Wells Fargo (WFC). Over at Morningstar.com, one veteran stock picker has looked at WFC's fundamentals and recent price decline and called it a buy. He's very enthusiastic and reports he just bought WFC. While impressive at first read, his "burn down" analysis is unpersuasive for me because it's still very speculative. So little of the next six months of economic history can be predicted with a reasonable degree of confidence.

Another Morningstar analyst, Jaime Peters, is much more cautious and warns Morningstar's premium subscribers that there are many reasons to worry about WFC. Peters has adjusted her thinking about WFC to reflect its recent acquisition of the troubled Wachovia, which puts Wells Fargo into the much more competitive national retail banking and mortgage markets. The acquisition also made Wells one of the four largest banks, which means it's likely to be a big target for politicians who intend to significantly tighten regulations on the big banks.

Peters also sees Wells' generous dividend as being at risk along with the dividends of so many other large TARP banks, which have taken billions from the Troubled Assets Relief Program enacted last fall. And I think that while Wells is considered well managed, a smart CEO and board wouldn't have bought Wachovia and made Wells Fargo as vulnerable to the recession and politicians as it is today. How vulnerable only time will tell. Peters, despite her concerns, gives WFC a still very inflated fair value estimate of $37. It closed Friday at $10.91, up from a 52-week low of $8.81 and down from a 52-week high of $44.69. To regain its high, WFC must soar 309.6%. How likely is that?

Neither Morningstar analyst discusses the stock's very bearish charts, which are here. Other reports rate WFC a sell or a neutral. Standard & Poor's had a 12-month price target of $19 when the stock was still at $15.76. I suspect that estimate will be lowered. Market Edge® Research calls the stock a "sell." That opinion was dated January 26, but the "SELL" opinion is still on the report.

Reuters Research Report, which like some of the others quoted here, is available on brokers' web sites, gives WFC a neutral performance rating, which means it will perform "generally in line with our coverage universe." This means that if you're bullish on the market, buy WFC. If not, sell. According to Reuters, as of Friday no analysts that it surveys were saying WFC is a buy. Six called it an outperform, which is bearish in this market. Six call it a hold, which is a sell in Wall Street speak. One calls WFC an underperform and five say "sell."

In the options market, traders of the WFC April $10 strike price calls say the stock will be worth $13.40 or more when the options expire. Traders of the WFC April $10 strike price puts say the stock will be worth $7.60 or less when the options expire 54 days from now. Volume and open interest numbers show there are a lot more bearish traders of WFC April $10 strike options than bullish ones. Options traders generally are credited with being smarter and more sophisticated traders than most stock traders.

After reading all the articles and reports, looking at the numbers and thinking about the political and economic risks facing WFC and other large banks, I'm very wary about Wells Fargo. You can say that the stock looks cheap and that there isn't much downside risk, but that's what the smart money said about Fannie Mae (FNM), Freddie Mac (FRE) and American International Group (AIG) when they were in their 30s, 20s, 15s and 10s. Those companies were nationalized last year and their stocks are virtually worthless today. Fundamental statistics and the latest news about WFC are here and here. Charts for seven other large banks are here. Click on a chart to see a gallery of charts.

Disclosure: author doesn't own WFC or any other companies mentioned in this piece.

Comments

[Vox Rationalis:]

Consider preferreds of any bank you believe will survive intact. Or consider PGF, an ETF of financial preferreds (40% or so U.S.), with an implied yield of about 20% at Friday's close. That assumes almost all of the dividends get paid - clearly, the market believes half of them or so will get chopped.

(long PGF)

Feb 23 09:09 AM

[Ishortyou:]

if the want the economic miracle they need to correct the oversupply in housing and take of the balance sheets from banks those MBS at cost price to stop them from requiring more capital injections and from writing more write downs.

Feb 23 11:00 AM

[everyotherc...:]

Mr Johnson, did you read the Morningstar analysis of 2-20-09? It goes into depth you hardly hint at and performs a "burn rate" analysis hypothesizing a huge hit to the economy over 2009 about twice what the most skeptical of our new nation of economists expect.

The analysis is written by the admitted most skeptical of the financial team, a man who has a history of shorting bank stocks. He makes a clear, objective and powerfull case for WFC. He also discloses his long purchase of WFC Friday.

If you haven't read the analysis Mr. J, here's the URL: news.morningstar.com/a...
It would add greatly to your understanding of WFC---why not read it and comment?

Feb 23 11:20 AM

[MIKETRADER:]

Preferrds loke more compelling atm, first beacause your equal to goverments take on the banks and second in some cases preferrds is at more discount prices to its face value than common stocks to its Book Value and NAV.... some you want to consider are:

* WFC series L
* JPM series E, J, Y
* GE series A,R
* MS seires J, Z
* HSBC series A

Even subordinated debt is more attractive in a risk reward ratio... my view is that is to early to jump on commons given the uncertanity at the markets.

Feb 23 11:40 AM

[Donald Johnson:]

The analyst is the first link in my report.


On Feb 23 11:20 AM everyothercatstaken wrote:

> Mr Johnson, did you read the Morningstar analysis of 2-20-09? It
> goes into depth you hardly hint at and performs a "burn rate" analysis
> hypothesizing a huge hit to the economy over 2009 about twice what
> the most skeptical of our new nation of economists expect.
>
> The analysis is written by the admitted most skeptical of the financial
> team, a man who has a history of shorting bank stocks. He makes
> a clear, objective and powerfull case for WFC. He also discloses
> his long purchase of WFC Friday.
>
> If you haven't read the analysis Mr. J, here's the URL: news.morningstar.com/a...
>
> It would add greatly to your understanding of WFC---why not read
> it and comment?
>

Feb 23 11:55 AM

[winslow:]

Bottom fishing??????? This is not a typical down market

Feb 23 03:35 PM

[Maklo:]

1. The author tends to argue based on the 1-day stock price reaction to, in this case, a non-event.

If your investment horizon is 6 months, then you are betting on how the markets will react. I personally think such a complex system like the stock market is incredibly difficult to predict.

My investment horizon is much longer than 6 months, so the market reaction to a non-event is not admissable as proof in my book.

2. The author tends to argue positions without supporting evidence. For example, he is arguing that the Wachovia acquisition was unwise. But as evidence, he mentions that it puts Wells Fargo into the "much more competitive national retail banking and mortgage markets" as well as making them "one of the four largest banks". Both points are either incorrect as well as illogical. Wells Fargo is in fact already the most competitive bank in retail banking and making consumer mortgages as measured by its market-leading (by a significant amount) net interest margin of 4.8% compared to the next highest big bank (JP Morgan < 3%). The Morningstar analyst in fact presents a cogent argument by looking at a very conservative scenario -- where 15% of the portfolio is charged off -- and shows how the company could still survive with a relatively low capital need.

The author calls this "speculative", which I find ironic because the same author lends credence and uses as part of his argument short-term behaviour in April-strike options prices!

3. The author also employs a classic strawman argument, citing that the "smart money" said the same thing about Fannie Mae, Freddie Mac and AIG so why should it not be the same with Wells Fargo?

I will not argue the blindingly obvious here. The point is, this is a non-argument, especially absent any other cogent points leading up to it.

Feb 23 08:35 PM