You've Got To Respect Wells Fargo

| About: Wells Fargo (WFC)

Even though I work in the finance industry, I don't like buying bank stocks because it is nearly impossible to fairly value a bank stock, so it is very difficult to tell whether a bank stock is overvalued, undervalued or fairly valued. High leverages banks enjoy and being able to manipulate value of asset holdings always gives banks an unfair advantage when it comes to valuation.

Also, it is nearly impossible to know all the risks a bank is exposed to. For example, there is no knowing how much European debt exposure Citibank (NYSE:C) has. On the other hand, there is a bank that stays away from most of that noise and makes money in the classic way, through fees, interest and commissions. This bank is Wells Fargo (NYSE:WFC) and this is one of the few banks I would feel comfortable investing in.

During the 2011 sell-off, Wells Fargo did not suffer as much as other banks did as the bank didn't have any exposure to all the drama in Europe. The stock price fell from $29 to $22 but it recovered back to $31 shortly after.

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In Warren Buffett's (NYSE:BRK.B) words: "The banking industry is back on its feet, and Wells Fargo is prospering. Its earnings are strong, its assets solid and its capital at record levels." Buffet owns 7.7% of this bank. While P/E ratios usually aren't meaningful on banks due to complexities in their earnings, Wells Fargo is an exception as its earnings are fully operational earnings as mentioned above.

Banking industry is performing much better in 2012 than it did in the last few years as they are still recovering from 2008-09 mortgage crisis. According to The Federal Deposit Insurance Corp (FDIC), in the last quarter of 2011, banking industry increased its earnings by 23% compared to the last quarter of 2010. Overall, two thirds of all banks reported improving profits and only one fifth reported having a quarter with no profit.

In the last quarter, banks working with FDIC earned a total of $119.5 billion. Bigger banks reported higher growth than smaller banks. FDIC has a list of "problem banks" which refers to banks with the highest potential to go insolvent. This list shrank slightly compared to 844 "problem banks" in the last quarter of 2010. The trend is in favor of the banking industry.

In the last decade, Wells Fargo's P/E ratio usually moved between 13 and 18, and the company currently enjoys a P/E ratio of 11. Wells Fargo's current price to book value is 1.27, which is less than half of 10 year average and 40% lower than the company's 5 year average. In the last 12 months, the company's revenue reached $81.2 billion. The company turned $15.9 billion of this revenue into earnings. Wells Fargo continues to see growth even though many of its former customers switched banks in the last year because of certain fees and practices.

According to a study conducted by J.D. Power and Associates, 10% of bank customers changed their banks in 2011, and West Fargo was one of the major banks suffering from this trend. In 2012, Wells Fargo is expected to grow its earnings by 12.50% whereas banking industry is expected to grow its earnings by an average of 8.40%. The earnings estimates give the company a forward P/E ratio of 9.86. The chart below shows Wells Fargo's P/E values over the last 5 years.

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Well Fargo's bonds are rated A2 by Moody's Investors Service, A+ by Standard & Poor's, and AA- by Fitch Ratings. Keep in mind that during 2011 crisis, rating agencies downgraded hundreds of banks of a variety of sizes from all over the World and many of these banks got downgraded by multiple notches. Considering this, Wells Fargo has pretty solid credit ratings, which means that rating companies believe that the company will not have trouble paying off its debt anytime soon.

Last month, Wells Fargo's website earned the award of "Best of the Web Compuware Web & Mobile Performance Awards for 2011." This may sound minor, however online banking is a major component of banking experience, and customers are more likely to conduct business with banks whose online banking is superior to others.

The company is currently trying to work out a settlement with the federal government and 49 states over its foreclosure practices. The settlement is expected to be as big as $5.3 billion. By paying this fee, the company will be free of all the lawsuits and claims related to the issue. The company says that this money will be paid by Wells Fargo's cash put aside for credit losses and some other allowances..

Wells Fargo is looking to increase its business by acquiring other companies. Reportedly the company seeks to buy auto-lending business unit of Ally Financial Inc, which is owned by the government at the moment. This company offers loans for General Motors (NYSE:GM) and Chrysler cars. This is the fastest growing business segment of Ally Financial and could be very beneficial for Wells Fargo.

Citibank is also said to be interested in another segment of Ally Financial. Meanwhile, the company might also start selling its shares publicly this year as government owns about 3/4th of this company. However, the company needs to clear its mortgage related issues before going public in order to maximize its price. Furthermore, Wells Fargo is in the process of buying a lending unit BNP, France's largest bank. This unit lends to a portfolio of energy companies mostly based in US and Canada. After this acquisition, Wells Fargo will have business relationships with over 175 oil and gas companies.

Among the 23 analysts covering the stock, 16 rate it as "strong buy," 3 rate it as "buy" and only 1 rates it as "sell." Analysts have an average target price of $35 on this stock, which gives it a 12% upside in the next year, given the company's current stock price of $31.35.

Disclosure: I am long WFC.