Wells Fargo's Economic Moat And Valuation Make The Company An Attractive Investment

| About: Wells Fargo (WFC)

Wells Fargo (NYSE:WFC) is a company with strong economic moat, and the current valuations make its equity an attractive investment today.

Because its reputable banking franchise and focus on cross selling, Wells Fargo is able to enjoy one of the lowest cost for interest-bearing deposits (2010: 0.45%) that translate into one of the highest net interest margin (2010: 4.26%) among its peers - Citigroup (NYSE:C): 2.97%, JPMorgan Chase (NYSE:JPM): 3.00%, Bank of America (NYSE:BAC): 2.61%).

In a commodity business like banking, the producer who has the lowest cost will always capture the most economic benefits. Despite the commodity nature in banking, a well-run banking franchise is very profitable because it can employ leverage with excellent margin of safety, backed by a real asset like housing.

At current share price, even if we assume that Wells Fargo has no growth in its loan portfolio in the next couple of years as the US economy works its way through the excessive leverage from the past couple of years, a normalized loss provision would suggest that Wells Fargo is currently traded at 7 to 8 times normalized earning and earning double digit ROE that can be profitably reinvested for future growth.

In addition, Wells Fargo has maintained its prudent underwriting policy and use of leverage to further enhance its competitive position by acquiring Wachovia during the most recent financial crisis.

Furthermore, record low housing start and record high housing affordability are potential catalysts to drive business growth at Wells Fargo.

Some may say that Wells Fargo is subject to the "Too big to fail," and will be penalized by the regulation changes. However, size by itself does not impose a hazard to the overall economy. The danger lies in the operators of financial institutions, both big and small, to take a free ride with excessive leverage and poor underwriting: heads they win big; tails they tried again (while the others got wiped out). AIG FP, LTCM, and some of the derivative trading desks would be examples of that danger.

Wells Fargo has maintained a conscious mind on leverage and underwriting. The low-cost deposits and reputable banking franchise that drive the success of Wells Fargo would not be altered by regulations.

Disclosure: I am long BAC.