Wells Fargo's profit surpassed its rival JPMorgan in 2013 as it released more from its credit reserves, but the nation's biggest mortgage lender saw its core business sag as yields on mortgages rose. Growth in its brokerage and investment bank helped it diversify, but not enough.
So says a CNBC article published today, titled "Guess who were the unlikely bank earnings' winners".
Three things went through my mind as I read this. Only partially censored, and in the following order:
- ... what?!?!?!
- Excuse me?
- I really need to lay off the coffee, because I can't be reading this right.
I just recently discussed a Bloomberg article which made the claim that bank earnings were the result of accounting wizardry, lumping Wells in with the bunch due to its reserve releases. I obviously disagreed. But I thought, with the usual flood of earnings-related articles over, that I wouldn't have to revisit the topic until next quarter.
Cue the previously-quoted CNBC article.
It starts by making the mistake of saying that Wells Fargo's (WFC) "core business" (implied to be mortgages) sagged. It's a common mistake to think of Wells as dependent upon mortgages, because it's certainly one of the elephants in that market. However, being a big player in mortgages does not necessary correlate to mortgages being a big part of your business. Consider a real estate investor who owns half of the homes in a neighborhood. He might be a big player in that neighborhood, but if he owns 1,000 homes across the country, that neighborhood hardly represents his "core business".
So too with Wells Fargo. In what might possibly be my favorite graphic in any company's earnings release this quarter, it breaks down where its revenue comes from.
This disproves both the idea that mortgages are Wells' sole "core business", and the idea that "growth in its brokerage and investment bank helped it diversify". They were already pretty diversified, wouldn't you say?
As if those mistakes weren't sufficient for a mere few sentences, the quote goes on to say that the strong results in brokerage/IB "weren't enough".
Huh? Last I checked, Wells reported another consecutive quarter of record EPS, despite the following happening to mortgages:
Why am I so worked up about this? Why do I care about one solitary article that makes basic and material mistakes in presenting Wells Fargo's business model in a sea of thousands of articles?
For one, I care because I happen to own a significant stake in Wells Fargo warrants. But more broadly, I care because there are many investors (especially retail investors) who trade on information that is either blatantly incorrect or what my good friend Thomas Finser calls "first-level analysis". (For an example of real, thorough analysis, please check out one of his articles.)
In investing, perception is often as important as (if not more important than) reality. Stock prices reflect what people believe subjectively about the stock, which may or may not differ significantly from the fundamental, objective facts. How does this dichotomy form? It's a basic human tendency to make mental models to simplify complex situations. Everyone does this to some degree. I would argue that very few people, even professional investors, have the capacity to understand every lever affecting every aspect of a business at every point in time. There's just too much information. So we focus on that information which is material to an investment thesis; if something is not material, we tend to ignore it.
There is nothing inherently wrong with this approach; in fact, the Pareto principle (often called 80/20) is generally useful. Figure out what matters and focus on that. However, what often ends up happening is the models become too simple, or people forget to change their model when the underlying business warrants such a change. Examples include Capital One (COF) still being thought of as focused on high-balance revolvers (it's not), or Intel (INTC) still being thought of as just a PC company (it's not). These perceptions exist because one person says them, and someone else says them, and pretty soon everyone else is saying them - and because everyone's saying them, they must be true, right? While analysts are somewhat less likely to make this mistake, they're not immune. I've read many reports (from both sell-side and buy-side analysts) that make critical mistakes in understanding the true drivers of value creation for a company.
Retail investors, whether in Wells Fargo or any other company, should do the following three things to avoid making such mistakes:
- Never make an investment decision (buy, sell, long, short, whatever) without doing primary-source research. Even the best, most professional, most credible sources can occasionally make a typo, or misinterpret a key piece of data. If something sounds weird - whether too good to be true or too bad to be true - then check the company's actual filings. Simply reviewing Wells Fargo's earnings presentation, which is constructed with graphics (like the one presented above) that are easy to interpret regardless of your level of experience in financial analysis, would have told you that the company is plenty diversified. There's nothing wrong with reading news articles about companies to get familiar with the story - I do this all the time. They can be quite useful and at least point you in the right direction. But to seal the deal, you need to go to the root source.
- Understand that if everyone says something, a lot of the time it may be true. For example, basically everyone knows/says Wells is one of the best-managed banks out there, and that is a fact. But sometimes, when what everyone says isn't true, it can be an opportunity for you to profit.
- And finally, if reading a random news article that doesn't contain any materially new information makes you reconsider your investment decision, then you either didn't do enough research or you aren't certain enough of the work you've done to justify holding a position in the stock.
Investing isn't rocket science, but it's not an endeavor for the intellectually lazy.
Disclaimer: This is solely my opinion, not an investment recommendation or solicitation, and may not represent the views of my employer(s), associates, or other related parties. No guarantees made to accuracy or completeness. I am long the companies mentioned in the disclosure and may change my position at any time without notification. Please see the full disclaimer in my profile, and do your own due diligence before making any investment.
Additional disclosure: I am long WFC warrants and COF warrants.