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Summary

  • We pitch two companies from the banking sector, Wells Fargo and BB&T, against one another in the latest instalment of our Head-To-Head series.
  • The article focuses on the relative strengths and weaknesses of Wells Fargo and BB&T based on business performance and dividends/forecasts.
  • It ends with discussion of the current valuations of the two companies, and details whether Wells Fargo represents good relative value at current price levels.
  • We chose to compare Wells Fargo and BB&T because of their similar yields, but markedly different recent financial performance.

Wells Fargo Background

Wells Fargo (NYSE:WFC) was founded in 1852 and is headquartered in San Francisco, California. It provides retail, commercial, and corporate banking services to individuals, businesses, and institutions. The company's Community Banking segment offers checking and market rate accounts, savings and time deposits as well as individual retirement accounts. Its Wholesale Banking segment offers commercial loans and lines of credit, letters of credit, asset-based lending and equipment leasing. The company's Wealth, Brokerage, and Retirement segment offers financial advisory, wealth management, brokerage, retirement, trust, and reinsurance services. As of March 7, 2014, it operated through 9,000 locations and 12,000 ATMs, and had offices in 36 countries.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance and that pay a decent, well-covered dividend.

We analyze each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Dividends/Forecasts

  1. Dividend payout ratio
  2. Forward yield
  3. Annual EPS growth forecast

Once we have analyzed the two companies based on the first two buckets, we can then assess whether they represent good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. 5-year price to earnings growth ratio

So, for example, a company that performs well compared to its rival on the first two buckets (business performance and dividends/forecasts) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below provides the data that we will use to analyze Wells Fargo and BB&T (NYSE:BBT) for the first two buckets.

Stock

Wells Fargo

BB&T

Business Performance

Return on equity

13.47%

9.16%

Return on assets

1.53%

1.12%

Operating margins

43.80%

39.03%

Quarterly rev. growth

0.60%

-7.49%

Quarterly EPS growth

3.80%

-24.68%

Dividends/Forecasts

Dividend payout ratio

30.00%

36.00%

Forward dividend yield

2.60%

2.40%

Annual EPS growth forecast

3.89%

12.10%

Wells Fargo has performed strongly in our first two buckets, with the bank delivering impressive levels of profitability, as well as top and bottom-line growth. For instance, Wells Fargo's return on equity is a very healthy 13.47%, while its return on assets continues to improve and is now 1.53%. Furthermore, Wells Fargo's operating margins continue to highlight just how profitable the bank is, with them being ahead (as are return on equity and return on assets) of its regional peer, BB&T.

In addition, we're impressed by Wells Fargo's quarterly top and bottom line growth, with the company increasing revenue by 0.6% and earnings by 3.8% last quarter. The comparison versus BB&T, though, is slightly distorted due to mortgage and tax-related reserve adjustments being included that had a detrimental effect on BB&T's numbers. Earnings, for example, would still have shown a decline of around 9%, but would have been much better than reported were it not for those items.

Meanwhile, Wells Fargo continues to impress when it comes to dividends. The current yield of 2.6% could be enough to attract the interest of income-seeking investors, but we think such investors should certainly be attracted to Wells Fargo when its low payout ratio is also taken into account. Indeed, a payout ratio of just 30% means that the bank has considerable scope to increase dividends per share at a brisk pace going forward.

While Wells Fargo loses out to B&T in terms of analyst forecasts for next year's earnings growth (3.89% versus 12.10% for BB&T), we feel its overall performance in the first two buckets is strong and ahead of its regional peer due to its strong recent performance, high levels of profitability and scope to increase what is an already impressive yield.

Valuation

Due to its strong performance in the first two buckets it would be of little surprise for Wells Fargo to trade at a premium to BB&T. Let's see if it does.

Stock

Wells Fargo

BB&T

Valuation

Forward price to earnings ratio

12.03

11.90

Price to book ratio

1.64

1.29

PEG

1.29

1.77

The valuation multiples highlight the good value that is offered at both companies, with PEG ratios being less than 2 and price to book ratios being 1.64 or lower. However, on a relative basis we feel that Wells Fargo deserves to trade at a higher premium than at present to BB&T. For instance, its P/E ratio is just 1.1% higher than its smaller peer, while its price to book ratio is just 27.1% higher. For us, these premiums are too low and highlight the better value that is on offer at Wells Fargo.

In addition, Wells Fargo's PEG ratio is currently at a 27.1% discount to that of BB&T (1.29 for Wells Fargo versus 1.77 for BB&T). This highlights the attractive valuation of Wells Fargo versus its sector peer and, as such, we feel that it could outperform BB&T going forward.

Conclusion

We're encouraged by Wells Fargo's performance in the Team Money Research Rating System, where its scores are stronger than those of regional peer, BB&T. Indeed, Wells Fargo appears to be a high quality company with considerable potential. Furthermore, its relative valuation looks rather low when compared to that of BB&T and, as such, we believe that Wells Fargo could outperform BB&T going forward.

Enjoyed this article? Why not check out our previous Head-To-Head battle between two prominent technology stocks by clicking here.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.