Over the past year, investors in Wells Fargo (WFC) have been rewarded by a strong return of around 18%. This return is exemplary, and in this article, I will present the case that Wells Fargo has further upside potential. Rather than relying on subjective analysis, I have quantitatively analyzed Wells Fargo to provide an objective recommendation.
A History of Returns
In order to fundamentally analyze Wells Fargo, I have relied heavily on return on assets. Return on assets is a metric which is calculated by taking the average total assets across an operating cycle and dividing it by net income to the firm. The utility of the metric is that it allows an analyst the ability to see how effectively management uses its asset base to generate profits. Wells Fargo is a money lending bank, which means that for the most part, its asset base is in the form of lending or investment. According to its recent statement of earnings, Wells Fargo's assets consist of 79% "long term investments," or interest bearing loans and other assets. This practically means that as we study return on assets for Wells Fargo, we are really studying how well management is able to generate a return on its lending. The chart below shows 5 years of return on assets for Wells Fargo.
In the bullet points below, I will discuss four distinct economic time periods in the history of Wells Fargo. Beneath the discussion, I have included a table summarizing the results.
- The first period of our analysis is from the second quarter of 2008 until the first quarter of 2009. This period of time was marked by a meltdown in the financial and world markets and Wells Fargo was not sheltered from the economic storm. Return on assets decreased to the point where Wells Fargo was nearly operating at a loss and investors fled shares leading to a 34% decline in share price.
- The next distinct economic period of Wells Fargo was from the second quarter of 2009 until the first quarter of 2010. During this period of time, Wells Fargo experienced a rebound in its effectiveness as generating profits from its lending activities, as measured by a return on assets. This regrowth of business led to expanding profits and a healthy rebound of 43% in its share price.
- During the second and third quarters of 2010, Wells Fargo experienced a period of economic decline in that its returns were stagnant. What this tangibly meant is that during this period, Wells Fargo experienced a decrease in ability to generate additional profits from its lending activity. Investors do not enjoy parking capital with firms that do not deliver return and during this time period, shares decline 16%
- The final period of economic activity which provides a basis for this article is from the fourth quarter of 2010 until the second quarter of 2013. During this period, Wells Fargo has managed to almost double its return on assets. What this essentially means is that over the past two and a half years, Wells Fargo has doubled its effectiveness at generating fresh profits from its lending activities. Yield-thirsty investors have flocked to Wells Fargo's shares over this time period, leading to a growth in share price of 53%.
The table below summarizes the points discussed above.
It can be seen in the above table that a fundamental relationship exists between firm performance and share price performance. Throughout the past 5 years, Wells Fargo has exhibited a consistent relationship in that as it improves its ability to generate profits, the market responds by buying its shares. Conversely, as Wells Fargo has decreased in ability to generate fresh profits, the market has sold its shares. This fundamental relationship is not only simple and logical, but it has also proven profitable over the past 5 years. In light of this relationship, I believe that investors should consider purchasing shares to capitalize on the growing returns of Wells Fargo.