Post 2008-09, investors have been reluctant to consider financial stocks as part of their portfolio, and understandably so. They represent what technology stocks did after 2001; highly leveraged bets based on assumptions with no real underlying value. Nevertheless, it is my view that the next decade will mark an increased trend of worldwide economic growth, and in turn a series of vast growth opportunities for the financial industry. More specifically, those financial institutions that have a presence in a wide range of businesses will be the ones in the best position to grow and weather shocks in any one particular sector. In this regard, Wells Fargo (NYSE:WFC) is one of the best positioned banking firms to grow revenues across a variety of business sectors.
This year, Wells Fargo became the world's largest bank by market capitalization, most recently measuring at over $240bn. In addition, Warren Buffett (who would not typically have a preference for financial companies, or companies in any over-leveraged industry for that matter) recently increased his stake in the company to over $20bn. Despite the ongoing issues in the banking industry, Wells Fargo has emerged as having a solid financial record relative to its competitors. I believe this is because Wells Fargo has not been over reliant on the investment banking industry to the extent its competitors have been. Instead it has continued to flourish within the retail and commercial banking sectors, while also continuing to increase its performance across other functions traditionally associated with investment banking, such as underwriting, loan syndications, and wealth advisory services. Even in a low interest rate environment, the company witnessed growth across all three of their main businesses, as outlined below.
Given the company's ability to achieve higher net profit margins in a low interest rate environment, WFC's prospects look highly favorable, especially if interest rates should rise in the future. Using the latest available data from the company's annual report, revenues from WFC's Community Banking business were up by 15%, with their Wholesale Banking and Wealth, Brokerage and Retirement businesses up by 11% and 4% respectively. Clearly Wells Fargo provides a strong offering across a range of products and hence, possesses the capacity to steadily grow its revenues across a wide range of sectors in the financial industry going forward. In fact, there are three broad-based strengths that I identify as driving WFC's growth over the next decade:
1. Recovery In The Real Estate Sector.
In terms of current price-to-rent ratios worldwide (which measures whether it is more economically viable to buy rather than rent a house), the US is one of the few countries in the world today where buying a house makes more economic sense, with rents rising faster than house prices. While some argue that Wells Fargo is potentially overexposed to the mortgage business, I would argue that the company has managed their risks effectively through more careful use of leverage relative to their competitors, which is reflected in a lower debt to equity ratio as discussed below. In addition, consumers will inevitably need to make a decision at some point as to whether to buy or rent a property, the decision being made in terms of which option is more financially affordable. Given the projected upturn in real estate over the next ten years, I see the firm's concentration in the mortgage business as a strength, and the firm has shown an ability to bounce back from short-term shocks in this sector.
2. High degree of cross-sell at a time of eroding bank loyalty.
Simply put, cross-sell measures the extent to which a customer relies on the one banking provider to obtain multiple financial products. The nature of financial services has changed, with customers increasingly aware of the range of financial products on offer and are willing to use another provider if necessary to meet their financial needs. According to Bain & Company, over half of customers in developed countries and 83% in emerging economies opened a new banking product over the last year, with one-third of these products coming from a bank other than the customer's main banking provider. However, Wells Fargo has bucked the trend in this regard, with cross-sell growing to 10 products per household in 2012.
3. The firm's presence in a range of viable businesses.
- Community Banking provides retail services to consumers and small businesses across a wide range of investment, insurance and trust services. This sector provided $10.5 billion in net income for 2012, and retail bank cross-sell was 6.05 products per household in the fourth quarter of this period. In fact, performance across the small business sector was particularly strong for WFC, with the firm increasing new loans to small businesses by 30% in the previous year, and continuing to maintain "small business lender" status throughout the past ten years based on total dollar volume in the US market.
- Wholesale Banking caters to the commercial space, providing financing to businesses with over $20m in annual sales. Product offerings within this business are more capital markets oriented, and include services such as treasury management, principal investments, asset management, institutional banking, and so on. Revenue from this sector increased by $2.5 billion to a total of $24.1 billion, thanks to growth from acquisitions as well as growth in non-interest income.
- Wealth, Brokerage and Retirement primarily caters to high net worth clients, providing services such as financial planning, private banking, credit, investment management and trust. Net income from this business was reported at $1.3 billion in 2012, up by $47 million from the previous year.
4. The firm has a solid track record of financial performance relative to its major competitors.
In terms of market capitalization, JP Morgan (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C) are Wells Fargo's largest competitors. As a means of financial analysis, I compared each firm's performance on the following five metrics; Return on Equity, Debt/Equity Ratio, 5-Year Earnings Growth from 2008-2013, current P/E ratio relative to 5-Year High, and the 5-Year Average Dividend Yield.
Wells Fargo clearly outperforms in three major areas (as highlighted in green). As can be seen from the above:
WFC has the highest return on equity of all four banks at 13.43%.
WFC also has the lowest debt/equity ratio of all the major banks. In fact, despite the argument that the bulk of over-leveraging in the mortgage sector is what caused the financial crisis, WFC has a lower debt/equity ratio than other investment banks who were also over-leveraged. Even with a high presence in the mortgage business, WFC would appear to be more financially prudent than its rivals.
WFC has the highest return on earnings from 2008 to the present at 416%, nearly double that of JP Morgan at 222.63%.
Of the four banks, WFC appears to be quite undervalued, with its P/E ratio only slightly above one-third of its five-year high. Only JPM seems to be more undervalued on a real earnings basis.
WFC has a respectable dividend yield of 2.10%, beaten only marginally by JPM and C with a yield of 2.3% and 2.4% respectively. However, I am of the opinion that Wells Fargo's impressive financials in other areas will mean a stronger and more sustainable yield going forward.
In conclusion, it is my view that Wells Fargo's strong financial position, along with its presence in a range of solid businesses, are reasons to expect great things from this company over the next decade.