The CEOs of the nation's most powerful banks met with the Fed on Wednesday to go over results from recent stress tests. As a result, all eyes are on the financial sector.
Often, stocks in the financial sector move in tandem. When markets are shooting up from the bowels of recession, or are recovering from a recent dip, the financial sector often leads the charge. Such was the case in 2009 when hedge fund titan David Tepper piled into financial stocks to reap profits of $7 billion. The financials also led the recent resurgence of the S&P 500, beginning in late 2011 until now.
However, financials are also hit very hard during downturns. When markets seize up, banks often have to tighten credit, limiting their profits. Also, investors often buy up treasuries during sagging markets, which depress interest rates. Coupled with a decline in interest rates from the Fed, these characteristics hit banks hard. As such, they can be volatile investments during market peaks and at the apex of boom cycles.
But how can you play the financial sector when markets are topsy-turvy, neither booming from a low nor free falling from a high? The answer is good old-fashioned critical thinking and research.
Below is an evaluation for financial firm Wells Fargo-an often overlooked security compared to its Wall Street counterparts.
Wells Fargo (WFC), which traded around the $33 mark Friday, is a strong company. The bank, led by CEO John Stumpf, is not sexy. It is focused. It lets the investment banks do the investment banking, and it sticks to its core area-lending. The bank is adept at playing interest rates correctly, earning half of its revenue from interest margins.
In Q4 2011, the bank booked a return on equity of 12% and a return on assets of 1.25%. Is this good? JPMorgan's (JPM) return on equity and return on assets were 8% and .65%, Bank of America's (BAC) were 3% and .36%, and Citigroup's (C) 2.6% and .61%, respectively. Yes, Wells Fargo's numbers are impressive.
The bank is also a quiet behemoth. Many investors do not realize that the bank has a market cap of nearly $175 billion. Numerous times throughout 2012, Wells Fargo boasted a higher market cap than Morgan Stanley (MS), Goldman Sachs (GS), and Bank of America combined.
Once I walked into a Wells Fargo branch and was greeted by three happy, smiling employees. I was incredibly impressed. The receptionist was warm (yes, they had a greeter), and the tellers were kind, helpful, and intelligent.
But I did wonder-where are all of their customers? After all, I was the only person there that was not employed by Wells Fargo. They were probably attending one of Wells Fargo's 51 "Home Preservation Workshops" that the company has held over the past three years.
What exactly is a Home Preservation Workshop?
It is one of Wells Fargo's keys to success. Up to 1,000 homeowners with underwater mortgages, a situation where the home is worth less than the mortgage loan, attend the workshops to try to improve their dire straits. Homeowners walk around the conference arena-after being fed snacks-with their W-2s, pay stubs, tax returns, mortgage statements, and other financial data.
The homeowners meet with an employee known as a "home retention team member" (note that Wells Fargo workers are not called employees, but are rather affectionately referred to as team members). There may be 100 or more of these team members at the workshop, looking to restructure mortgages for homeowners.
Yes. Wells Fargo's employees are willing, able, and encouraged to restructure mortgages on the spot, often reducing principle amounts or extending the life of the mortgage. For example, an underwater homeowner may roll a 15-year mortgage into a 30-year or even 40-year note in order to reduce monthly payments. Are these employees qualified to take this action?
They certainly are. The "team members" each receive a book signed by CEO Stumpf called Vision and Values, a 37-page guide to increasing revenues by serving customers and conducting themselves in a kind and professional manner.
What impresses me the most about this bank is that it makes its profits the old-fashioned (but proven) way-by being honest, displaying integrity, and carefully safeguarding against risks.
Previously I mentioned Wells Fargo's 12% return on equity and 1.25% return on assets. I am very impressed that the bank is capable of bringing in these types of returns without the aid of major investment banking or prime brokerage units (see below for prime brokerage). What these numbers indicate is that a bank with $1.3 trillion in low-margin assets at Q1's end is capable of bringing in a strong return, especially compared to its peers. Even more impressive is the company's focus on its core areas.
While the bank did get hit in the latest recession, it is watching the Eurozone mess from the sidelines. Foreign loans make up only 5% of its portfolio, giving the bank strong breathing room in case of a collapse. For this reason alone I absolutely love the company. If you desire to hold a bank stock but can't stand the thought of the Eurozone collapsing, this stock may be what you are looking for.
Wells Fargo is also expanding its business lines. While some would see this as a loss of focus, the bank is phasing into a strong position.
The company, which is the only large bank without a major prime brokerage business, is aiming to jump in with both feet. Wells Fargo aims to provide more trading, lending, reporting, and technology services to hedge funds as well as alternative investment firms. The company made its first foray into the space by buying prime brokerage firm Merlin Securities, a provider to more than 500 managers.
With the acquisition, Wells Fargo looks to boost its margins and to continue to support its core lending business.
In all, Wells Fargo is a safe financial stock with low exposure to the Eurozone. Customers adore the company, and it grows through traditional values. Perhaps this is why Warren Buffett also loves the stock-he is the company's largest shareholder.