Why Is Wells Fargo Warren Buffett's 2nd Biggest Holding?

Sep.22.12 | About: Wells Fargo (WFC)

In our earlier reports, we saw how fortune favored Wells Fargo (NYSE:WFC), and later why its second quarter earnings made us more bullish on the stock. The bank has a robust capital base and a simple business model, which relies heavily on mortgage loans. Since the U.S. housing market is recovering, we believe the bank will experience tremendous growth in the coming quarters. Therefore, we recommend our readers to buy the stock.

Bank Overview

Compared to most of the money-center banks in the U.S., Wells Fargo's operations are relatively comprehensible. In other words, the bank has a simple business model. Unlike the rest of the money-center banks that deal in the trading of complex derivatives and investment banking, Wells Fargo derives a large proportion of its revenues from fee-based activities and mortgage loans. The bank, which already does business with one in every three households in the U.S., has a vast customer base. Its operations are more domestically concentrated as compared to most of its peers.

Why Wells Fargo?

America's second-largest home lender also stands to be the most favored bank of billionaire Warren Buffett. The bank is set to be his second biggest holding in Berkshire Hathaway (NYSE:BRK.A). Buffett has increased his investments in the bank, owing to the rebounding U.S. housing markets. Buffett believes that the bank, being the largest mortgage lender, will benefit from the housing markets, which we believe have bottomed. There is plenty of data to suggest that U.S. housing markets are on their way to a recovery. The hugely successful mortgage operations of the bank will benefit from the mortgage market, which is expected to rise to as high as $3 trillion. If expectations are met, the bank might make $1 trillion worth of business from its mortgage operations alone. Wells Fargo reported revenues of $4.8 billion from its mortgage operations in the first half of the current year. Meeting the expectations will mean over 200% growth in revenues accruing from the bank's mortgage operations.

Earnings History

The bank has a history of surpassing its consensus earnings estimates, as shown in the table below. In the second quarter of the current year, the bank, despite posting a turnover figure that was in line with expectations, surpassed its EPS consensus estimate by 0.89%. Overall, the bank has surpassed its revenue and earnings estimates by 0.6% and 0.4%, respectively, in the past five quarters.

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Robust Capital Position

The bank has a solid capita base, as reflected by its Tier 1 capital ratio of 11.69%. The ratio has remained relatively flat over the past one year. Going forward, analysts at Credit Suisse (NYSE:CS) believe that the bank appears to be best positioned relative to Basel III recently enhanced minimum capital requirements. At the end of the second quarter of the current year, WFC had an estimated Basel III Tier 1 common ratio of 7.78%, while the bank is expected to reach over 8% with regards to its Tier 1 common equity ratio by the end of the current year. Also, the bank is considered to be best positioned to deploy capital to buy back shares.


WFC trades at a 36% premium to its book value, as compared to 54% and 46% discounts for Bank of America (NYSE:BAC) and Citigroup (NYSE:C), respectively.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Financials Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.