Why The Smart Money Is Right About Wells Fargo

| About: Wells Fargo (WFC)

Wells Fargo & Company (NYSE:WFC), which is best known as a multinational banking and financial holdings company, has witnessed a relative decline in its core mortgage portfolio, which pulled down total revenue from $21.2 last year to $20.5 billion. The bank has managed to cushion its losses by releasing part of the money meant for bad loans, but some analysts argue that the tapering of the mortgage business may put additional pressure on other segments of the company's highly diversified ventures. On the other hand, as will be seen below, the company retains a solid balance sheet, a great history of growth in dividends and an excellent valuation. Further, sectors other than mortgage banking showed healthy growth, arguing well for the future prospects of the company. Despite some tailwinds in the recent past the company has managed to perform better than its peers in terms of growth and remains a viable option for those seeking stable stocks with modest yields.

Slack in the mortgage market

Mortgages make up a major part of the profit earned by Wells Fargo. This profit fell by 43% in Q3 due to fewer loans and falling profit from the sale of such mortgages to investors. Fall in loans and mortgages however is indicative of the improving health of the economy, which will help drive consumer demand and loans in other sectors, according to Wells Fargo CEO John Stumpf. This economic improvement allowed the company to release $900 million kept aside for bad loans, thereby cushioning the impact of the slack in the mortgage sector.

However, some investors remain worried as to whether the company will be able to continue growth once the release of reserves has ended.

Solid balance sheet

Despite the fall in profit from mortgages, the company retains an excellent balance sheet. Wells Fargo's recent stock prices give it a market capitalization of around $232 billion, which is comfortably close to the $239 billion that appears to be the company's worth based on a discounted earnings analysis. Further, its debt to equity ratio is a healthy 1:2 and it has over $200 billion in cash reserves. These indicate that it possesses the ability to service its debt and withstand economic cycles without compromising the interests of shareholders.

History of dividend increases

The company has a payout ratio of 27%, which means it has almost two thirds of its earnings for investment. That said, the company was the first US bank to raise its dividends following the last market crisis. It currently pays $0.30 per share quarterly, which has remained the same for the last three quarters. This, coupled with its excellent balance sheet, indicates its stability and potential for future growth.

Growth in other businesses

Even as the income from mortgages declined, the company's earnings from other businesses rose. In particular, its fees from investment banking rose by 33%, while trust and investment fees rose from $2.95 billion a year back, to $3.28 billion. Further, as home loans fell, the company actually increased its loan book by 1.3% through increases in auto, credit card and commercial loans. According to Marty Mosby, equity analyst at investment bank Guggenheim Securities, "It's one of those transition quarters. As you move into the next quarter or two, you'll see temporary earnings being replaced" by sources of income that are more stable.

The investor's call

As seen above, a study of the company's balance sheet and dividend history should dispel any doubts about its long-term growth prospects. It is true that the company has suffered due to a decline in the mortgage market, but it has managed to grow in other sectors. Considering its excellent cash reserves and debt to equity ratio, it is reasonable to believe that the company should be able to complete this transition from heavy dependence on mortgages to a more even business portfolio without risking investor confidence. Hence, those seeking a healthy dividend paying stock with good prospects of long-term growth may consider buying into the company's stock. On the other hand, it would be advisable to hold onto Wells Fargo stock if one already owns the company's shares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.