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Summary

  • Low payout ratio gives the bank room to grow dividends in the future.
  • Strong earnings growth will support future growth in dividends.
  • Favorable macroeconomic conditions should allow the banking sector to flourish.

Wells Fargo (NYSE:WFC) is one of the largest banks in the U.S. with a market cap of $245 billion. The bank suffered from severe economic downturn and faced critical situation during the financial meltdown of 2008. However, as the banking sector has started performing well with the recovering economy, Wells Fargo has also started to show continued growth. Over the last year, the stock gained just under 30% and year-to-date, it is up about 4%. It looks like the good days are still in front of the bank and it will continue its upward movement.

Analysis of Earnings, Cash Flows and Dividends

The bank has recorded impressive earnings growth over the last three years - WFC's average annual growth rate in earnings has been over 12% during the period. The important point to note here is that despite some volatility in total revenues and interest income (core business), the bank has been able to grow its net income at an impressive rate. Liquidity is vital for banks as the entire loan assets portfolio is essentially backed by the deposits. As a result, the banks need to maintain a certain level of liquidity in order to meet the deposit withdrawals. Wells Fargo has maintained its loan-to-core deposit ratio at around 84%. It shows that the bank believes this level of the ratio to be the most efficient and about 16% of the deposits are deemed enough to meet the liquidity needs.

Wells Fargo is one of the few banks that are still paying attractive dividends. As a result, dividend investors are also attracted towards this stock. At the moment, the bank pays quarterly cash dividend of $0.30 per share, yielding over 2.5%. WFC distributed a total of $5.9 billion in cash dividends during the last year. Over the period of last year, the bank has also repurchased common shares of worth around $5.4 billion, returning over $11 billion to the shareholders. At the moment, most of the banks have low dividend yields due to the restrictions from the Federal Reserve. For example, Bank of America (NYSE:BAC) and Citigroup (NYSE:C) yield 0.20% and 0.1%, respectively. The bank has a payout ratio of about 27% based on its earnings, which gives it substantial room to grow its dividends in the future.

Valuation

Coming to the valuation - Wells Fargo has a price-to-earnings ratio of 12x compared to the industry average of 13.5x. However, the price-to-book ratio of 1.6x indicates the stock is trading at a premium relative to the industry - the industry average P/B ratio is 1.1x. However, it is important to value banks on the basis of tangible book value. At the moment, Wells Fargo has a tangible book value per share of $24.29, indicating that the stock is trading at a substantial premium compared to its tangible book value.

Future Prospects

Future prospects of the banking sector are bright in my opinion. As we have seen, the earnings growth of the bank has been strong in the last three years. I believe the recovering economic conditions will play a vital role in the future growth of the banking sector. Furthermore, the bank has been decreasing its provision for losses over the last few years, which indicates that the credit quality has increased and the bank is expecting lower losses in the future. As a result, the future profitability of Wells Fargo should be enhanced. In addition, the growing housing market also suggests that the banks will be able to do well over the next few months.

Conclusion

Wells Fargo has a large cushion when it comes to future dividend growth. Furthermore, the bank's performance regarding its earnings growth has been impeccable. I expect it to continue its earnings growth due to the recovering economy and the housing market. The growth in quarterly dividend of about 20% is far better than most of its peers and I believe it is a good investment for dividend hunters.

Source: Wells Fargo: A Good Dividend Pick?