I think I'm finally starting to understand why Wells Fargo (NYSE:WFC) is the largest bank holding for Warren Buffett, the largest bank holding for Charles Munger, and a regularly appearing bank stock in both the professionally managed portfolios of Seth Klarman and Donald Yacktman over the years.
To me, it seemed counterintuitive to accept that a megabank could possess superior qualitative characteristics. With name brands, I get it. I can understand how the Coca-Cola soda brand, or the Clorox cleaning brand, or the Colgate toothpaste brand, can create an economic moat that makes those companies superior over the long term. But once a bank has about a trillion dollars in assets, it seemed silly to me that an entity could possess the discipline to maintain high quality at such a vast size. Yet, evidence of Wells Fargo's risk-management superiority is right there in the numbers: only 0.47% of loans are charged off, while Wells Fargo sets aside 1.81% of loans to cover against charged off loans so that the company could see 4x as many borrowers collapse and still be covered.
Because of the company's superior business performance, Wells Fargo received approval yet again to raise its dividend, as the annual payout is increasing from $1.20 to $1.40 per share (a hike of 16.67%). With that, we can finally say that Wells Fargo's business operations, in total, have moved on from the financial crisis.
When you study the bank now, you will see that Wells Fargo is stronger today than it was in 2007. On the eve of the financial crisis (i.e. December 2007), Wells Fargo reported a tier 1 common ratio of 5.99%. Today, that figure is at 10.82%. According to the Fed stress tests this week, a simulated recession in which stocks lost half of their value would bring Wells Fargo's Tier 1 common ratio down to 6.1% (and that even includes Wells Fargo's plan to pay out $1.40 per share in dividend and repurchase 350 million shares). Translating that into English, Wells Fargo's capital is so high right now that it could endure another 2008-2009 type of crisis and still be better capitalized than it was entering the last recession in 2007.
The last element awaiting recovery for Wells Fargo shareholders has been the company's dividend payout. In the summer of 2008, Wells Fargo began paying out a $0.34 quarterly dividend that ultimately had to get slashed to a nickel per share in 2009. With Wells Fargo announcing a new $0.35 quarterly payout for the second quarter, the company's dividend payout has finally climbed above where it was during the start of the financial crisis.
The interesting thing, though, about the Wells Fargo dividend payout is that it is backed by noticeably higher profits now, compared to its pre-crisis figures. Before the financial crisis hit, Wells Fargo was making $2.38 in annual profits. The $1.36 dividend before the crisis hit accounted for 57.1% of the company's profits. Now, Wells Fargo is going to pay $1.40 in dividends to shareholders while the company is making $3.89 in profits. The dividend only accounts for 35.98% of the company's total profits. Even with a 16.67% dividend hike, Wells Fargo is still retaining twenty percentage points worth of additional profits compared to the pre-crisis figures of 2007.
The company also announced plans to repurchase 350 million shares of its stock. My expectation is that the company's buyback program will boost its earnings per share figures by roughly three percentage points. The company first started buying back stock in 2012, and reduced the share count from 5.481 billion to 5.260 billion (which reduced the share count by slightly over 4.0%). The current buyback authorization allows Wells Fargo to retire 6.65% of its outstanding stock, and it will likely take the company about two years to complete this program.
For dividend investors seeking a conservative bank account, there is a lot to like about Wells Fargo. Its current tier one capital ratio is 80% higher than it was on the eve of the last crisis. The company is only charging off 0.47% of loans. The company will be paying out $7.36 billion in dividends while making almost $21 billion in profits. The share count is getting reduced by about 3% annually. The dividend payout ratio has a bit of room to climb still, suggesting that Wells Fargo investors might get a couple double-digit dividend increases. Looking at Wells Fargo's capitalization, profitability level, and dividend payout, the bank is now officially better than it was in 2007.
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.