By Matt Doiron
Warren Buffett has held Wells Fargo & Co. (WFC) for a very long time, but this is the first time Wells Fargo is the biggest position in Berkshire Hathaway's 13F portfolio (see Q3 filing). Warren Buffett's holding company increased its holdings to nearly 440 million shares, and combined with changes in price, this made Berkshire's stake in the bank more valuable than its 400 million shares of Coca-Cola (KO) (see Buffett's favorite stocks). Wells Fargo was, in fact, one of the five most popular financial stocks among hedge funds (find more financial stocks hedge funds loved); billionaire John Paulson's Paulson & Co. was one major shareholder with a position of 3.5 million shares (research more stocks Paulson owns).
Wells Fargo is often seen as a more stable bank than many of its peers, and certainly has a better reputation than Citigroup Inc. (C) and Bank of America Corp. (BAC). In addition, analysts argue that Wells Fargo is well positioned to benefit from a recovery in the U.S. housing market due to its position in the mortgage market (which some larger banks have de-emphasized following the financial crisis). Currently, Wells Fargo carries a significant premium to the book value of its equity, with a P/B ratio of 1.4. The stock can support this valuation because in terms of earnings it actually looks cheap in terms of its trailing P/E of 11.
In addition, Wells Fargo has been growing its earnings quite well over the last year. For 2012, net income was 19% higher than the previous year; in 2011, the earnings growth rate had been 28%. Even a single digit growth rate on the bottom line would make the stock undervalued considering where it is currently trading. Both net interest income and non-interest income were up, suggesting that the improvement in Wells Fargo's financials is broad based. Yet over the last year, the stock price has risen about even with the market - about 10% - while many other banks have seen a much larger increase. For example, Bank of America is up 28%. Wells Fargo should also be noted for paying a dividend yield of 2.6%.
We've already mentioned Citigroup and Bank of America as peers for Wells Fargo. These banks are priced at a significant discount to book value, with P/B ratios of 0.8 and 0.6 respectively. However, their recent earnings performance has been significantly worse. In fact, Bank of America reported declines of at least 20% in both revenue and earnings in its most recent quarter compared to the same period in the previous year, and while Citigroup did experience net income growth, its topline numbers were not particularly good. Even in terms of forward earnings estimates, all three find themselves with P/Es in the 9-10 range. As a result, we would say that Wells Fargo has a much less complicated value case going for it.
We can also compare the stock to other banks including JPMorgan Chase & Co. (JPM) and U.S. Bancorp (USB). These two companies pay dividend yields of above 2%, close to Wells Fargo's. JPMorgan Chase reported strong results in the fourth quarter of 2012 versus a year earlier, and at a trailing earnings multiple of 10, we like it as a value prospect as well. U.S. Bancorp's growth rates have been more modest, and its valuation in terms of earnings is nothing special - actually, a small premium to Wells Fargo. Even though it is fairly cheap and performing well, JPMorgan Chase and Wells Fargo seem like better prospects.
Citigroup and Bank of America are certainly discounted enough in terms of the book value of their equity that they are worth watching, and it's possible that a closer look would show that they are back on their feet from a business standpoint. However, we think it is considerably safer to look at Wells Fargo and JPMorgan Chase since their trailing earnings are strong enough to justify their current valuation and they have been turning in impressive growth numbers.
Disclosure: I am long C.