Time to Buy Wells Fargo?

 |  Includes: C, GS, JPM, MS, WFC
by: Mark Riddix

While there has been much discussion about the trading practices at Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), JPMorgan Chase (NYSE:JPM), and Citigroup (NYSE:C), one of the nation’s largest banks has managed to stay out of the line of fire. That bank is Wells Fargo (NYSE:WFC). Wells Fargo is the fourth largest bank in the United States with over $1 trillion dollars in assets.

The bank is also a longtime Warren Buffett holding because of its great management team and efficient operating structure. Wells Fargo has recently come under pressure dropping roughly 10% over the past week to $28.71. Wells was punished by a Goldman Sachs downgrade of shares of the banking giant. Should you use the dip to buy shares of Wells Fargo?

First we need to determine how much Wells Fargo is worth? Revenue has been strong for the current year. Wells has earned over $99 billion over the past fiscal year. While this is clearly an outlier due to a favorable banking environment, it does bode well for future prospects. Wells historically has earned between $40 and $50 billion dollars over the past 5 years. It stands to reason that Wells could easily earn $45-$50 billion dollars annually. That figure doesn’t even include the full impact of the Washington Mutual acquisition. Credit losses from home foreclosures and loan modifications appear to be subsiding. As one of the largest home mortgage service providers, Wells Fargo stands to benefit from any stabilization in housing prices.

Net income can conservatively be estimated at $20 billion dollars. Factor in a minimum of $20 billion dollars in net income divided by a 5.2 billion float and you get an EPS of $3.85. Shares are currently selling at just 7 times normal earnings. Shares are also cheap based on book value, trading at just 1.45 times book value. It would be futile to try and calculate debt to equity since banks hide many of their obligations off the balance sheet. Return on equity and return on assets have been unimpressive recently coming in at 9% and 1% respectively. Over the past 5 years revenue has grown 24% and net income has risen almost 12%.

The economy may be recovering at a tepid pace but it is recovering nonetheless. The sooner that things return to normal, the sooner that financial companies will increase earnings and dividends will return. Since bank stocks should conservatively trade with a multiple of 10, a fair value for Wells Fargo is $38.50.

Disclosure: I do own shares of Wells Fargo.