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Summary

  • Wells Fargo has a cost advantage compared to its peers, which will result in higher margins.
  • The bank is using its deposits efficiently, and it retains the optimal amount (17%) of deposits for the withdrawals.
  • Wells Fargo is trading at the highest premium (121%) to its tangible book value compared to its peers.

Wells Fargo (NYSE:WFC) is the best-performing stock in the banking sector at the moment. The stock outperformed most of its peers since the start of the year - Wells Fargo is up over 8%, when the other stocks in the sector have lost value. Analysis of some of the key ratios shows that the stock is performing well due to the strength in the fundamentals of the bank. Furthermore, Wells Fargo is also not facing litigation issues like Bank of America (NYSE:BAC), which has been a drag on Bank of America's stock price. We have compared some of the key ratios of the bank with its peers, JPMorgan (NYSE:JPM) and Bank of America.

Wells Fargo is the Most Efficient Bank

First ratio in focus is the efficiency ratio, which is basically the cost-to-revenue ratio of a bank. A lower efficiency ratio means the bank has lower overheads and other costs compared to the total revenue. The following table shows the efficiency ratio of Wells Fargo, along with its peers.

Wells Fargo

JPMorgan

Bank of America

Efficiency Ratio

57.90

67.71

62.47

According to the above figures, Wells Fargo has the best efficiency as compared to its competitors. In fact, it has recently improved its efficiency by 40 basis points in the first quarter of 2014. In this area, WFC is ahead of its competitors by at least 400 basis points. This enhanced efficiency contributes to better margins for the bank. The cost advantage over other banks makes Wells Fargo an attractive investment, as its future margins are expected to be better as a result of lower costs.

Efficient Use of Assets

Now that we have shed some light on ratios related to income statement, let us move on to the balance sheet. The ratio in focus is total loans-to-total deposits. Banks have a simple business model: a bank takes deposits from people and loans it out at a higher rate than it has to give to the depositors. The spread between the two is the bank's profit. In addition, the ratio in focus points out other important factors, such as how efficient the bank is in using its assets to generate more business. In simpler words, if this ratio is higher, it means that the bank is generating optimal levels of revenue from the deposits available. If it is too low, it means that it is not getting enough business and profitability will be affected. However, as the ratio goes higher, the risk of the bank also increases. This is because if most of the deposits are loaned out, the solvency of the bank might be compromised, should it face any sudden withdrawals. The table below shows the total loans-to-total deposits ratio of these three banks.

Wells Fargo

JPMorgan

Bank of America

Total Loans-to-Total Assets

0.83

0.57

0.82

Wells Fargo is in the best position in terms of bringing in business. The ratio tells that 83% of Wells Fargo's total deposits are loaned out, on which it is currently making profit. Next with the advantage is Bank of America, with 82% of its total deposits loaned out. However, its efficiency offsets this advantage, resulting in lower operating profit. JPMorgan has 57% of its total deposits loaned out, and is considerably below Wells Fargo. In a case of sudden withdrawal of cash from depositors in adverse market situations, JPMorgan will be on the safest side. In our opinion, 17% of deposits provides enough cushion for sudden withdrawal in normal situations.

Premium in Price is Backed by the Performance

Next ratio in focus is related to valuation, i.e. price-to-tangible book value ratio. Tangible book value separates the intangible assets, such as goodwill and patents, and gives the value of pure tangible assets. In simpler words, it gives an idea of how much the assets of the bank would value in case of liquidation. The value is further broken down to tangible book value per share. It is then compared to the market price of the stock to find out if it is trading at a discount or premium. The following table shows the tangible book value per share of the three banks, along with their current price.

Well Fargo

JPMorgan

Bank of America

Tangible Book Value per share

$22.17

$38.68

$13.11

Current Price

$49.08

$54.01

$14.74

Premium/(Discount)

121%

39.63%

12.4%

Usually, banks trade at a premium to the tangible book value, as the table above shows. Wells Fargo is trading at a massive premium due to the better performance by the bank compared to its peers. JPMorgan is trading at a moderate premium; however, it is sitting on huge deposits which have not been loaned out yet. This represents a huge opportunity cost, which Wells Fargo has very efficiently avoided. Bank of America is currently trading at the lowest premium to its tangible book value compared to the other stocks mentioned here, and it might bring considerable gains for its shareholders over the next two-three years as the stock moves to the average premium in the sector. For a detailed analysis of Bank of America's current situation, please follow this link.

Conclusion

Wells Fargo is one of the best performers in the banking sector, and the strong operational position of the bank has been the reason for its impressive performance. It is also one of the best dividend stocks in the sector, as we have detailed in a previous article. We believe Wells Fargo's better operational position, as well as the recovering economy will allow the bank to continue its growth over the next few years.

Source: Is Wells Fargo The Most Efficient Bank?