Income Investing: Don't Get Blind-Sided By Misinformation

| About: Wells Fargo (WFC)


Recently I came across a feature about why Wells Fargo looked attractive today.

The basics make a good deal of sense, but the passage also highlights that the stock had actually gained during 2008 whereas the market was down substantially.

This article demonstrates why that’s quite misleading and why it’s important to not fall for the media’s mumbo jumbo.

Recently, I was flipping through Money Magazine and happened upon a passage about Wells Fargo (NYSE:WFC). In particular, it detailed why the security looked attractive: solid credit rating and return on equity, low comparative valuation, strong profit growth and the stickiness associated with its customers having multiple (more than six) accounts or relationships with the business. All of these things are solid motives to like the company, and indeed, I agree that the security looks reasonable today.

Yet the end of the commentary - "the verdict" - was a bit disconcerting. I'd like to share that excerpt and then hopefully demonstrate why you should be cautious in blindly accepting what's reported. Here's "the verdict":

"With most financials, economic troubles usually spell trouble. Not so with Wells. When the market dropped 37% in 2008 because of the housing collapse, Wells' stock gained 2% on investor confidence in management, which still exists today."

This is the sort of thing that ought to be disconcerting for those that know the history of the security. I'll get to the numbers shortly, but think about how an everyday reader might react to that statement.

Naturally, we have no way of easily polling the general audience, but let's offer a hypothetical. Based on what was presented, here's my imagination of what the everyday reader might have thought: "Wow, I remember the market crashing, the recession, the housing bubble, all of it. Boy, was that a tough time. And here I come to find out that Wells Fargo, a bank, did just fine (actually up!) during that year. I'd sure like to find a safe haven for the next financial crisis. Wells Fargo sounds like a perfect choice to me."

And the interesting thing is that if you partnered with the company and forgot you owned shares for the next couple of decades, things could likely turn out just fine. Yet I think the reader audience here at Seeking Alpha gets why this type of sentiment can be so dangerous.

Let's look at the numbers. At the end of 2007, shares of the SPDR S&P 500 ETF (NYSEARCA:SPY) were trading hands around $146. By the end of 2008, the share price had declined to $90 or so. You would have also received $2.70 or thereabouts in dividends, for a total ending value of just under $93. Expressed differently, the annual return on the investable index was indeed roughly -37% for the year.

At the end of 2007, shares of Wells Fargo closed at $30.19. By the end of 2008, shares were trading at $29.48. If you add in the $1.30 in dividend payments during the year, your total value would have been about $30.78. Expressed differently, shares of Wells Fargo did indeed provide a 2% return for the year.

So the statement made in the Money Magazine excerpt is accurate. We just saw the numbers. However, I would contend that it is highly misleading for a number of reasons. The presumed safety and "confidence in management" doesn't tell you the whole story.

Volatility During 2008

When you hear "gained 2% for the year" it sounds like a small gain without much activity. It's the sort of return you'd anticipate from a certificate of deposit or something of the sort. Yet this certainly wasn't the case for Wells Fargo. Investors would have been taken on a wild roller coaster ride during the year.

You would have started with shares worth $30 or so and by mid-January, the share price bids would be down around $26 before jumping up to $32 by month-end. By July of 2008 shares could have been had for $21 per share - a 30% discount to your beginning value. By September of 2008, shares reached a high of $44 before declining to $23 in November (a nearly 50% drop in two months). Finally, shares settled the year just under $30 per share.

Naturally I "cherry-picked" those high and low points, but that's the point. Wells Fargo investors had to stomach a whole lot of volatility for that 2% gain. Now to be sure, I advocate having a long-term mindset and staying the course. Yet you have to be prepared for 50% drops and massive volatility in-between. The 2% annual return that some like to quote doesn't do you much good if you sold at $22 in July.

2009 Numbers

Of course the largest issue with suggesting that Wells Fargo stock gained due to "investor confidence" is that the timeframe is rather convenient. From 2007 through 2008, shares basically stayed flat - that much is true.

Yet from the end of 2008 through March of 2009, shares went from ~$30 to under $10. Talk about your confidence. Once more investors had to have the stomach to hang in for a dramatic roller coaster ride down - this time to the tune of a 70% decline.

Moreover, here's where you could flip the script. Instead of saying look at 2008 when the crisis was starting and see how "well" shares of Wells Fargo did, you can say: "take a look at 2009." In 2009, the S&P 500 index rebounded, returning 26.5% with dividends included. Meanwhile, the Wells Fargo investor saw a negative 6.7% return.

I could throw in some commentary about investors not having confidence in management, but we all know that would be mumbo jumbo. Stock prices ebb and flow with the business results and expectations, so picking arbitrary timeframes (especially in the short-term) may not tell you much.

"Woe" Could Be The Income Investor

In addition to not accounting for the volatile and negative return that would follow the seemingly "upbeat" 2008 for Wells Fargo, the excerpt also fails to highlight the upcoming dividend cut. In April of 2009, after a very solid dividend increase streak, Wells Fargo reduced its common dividend from $0.34 per quarter to $0.05 - an 85% decline.

For the general reader who thought Wells Fargo came out of the financial crisis unscathed, this type of situation is a real possibility. And indeed, it's the sort of thing that the general population can get blind-sided by if they only rely on tidbits of the story.

The dividends per share paid on the index are now 50%+ higher, as compared to Wells Fargo were the dividend just reached its previous mark in 2014 - five years later - and is now 10% higher than it was.

Of course there are a variety of caveats for the astute investor. For someone familiar with the ups and downs, the ebbs and flows of the market, all of this may have been a great opportunity. Rarely do we invest just once and then sit on our hands and hope for the best. Instead, we invest regularly and over a great deal of time.

As such, the much lower share price, and even lower dividend, allowed for new capital (or at the very least reinvested dividends) to compound at a much faster rate. The investor who first partnered with the company at $30, had the opportunity to add more shares at $25, $20, $15 and so on (and even later again at $25, $30, etc.).

I'm quite cognizant of the idea that lower prices can offer opportunity, and not every dividend cut is a great tragedy. And indeed, the patient investor could have done better than the market (in both an income and total return sense) by continuing to invest in Wells Fargo.

Yet the general population and everyday reader may not also keep this same mindset. And that's why I found that excerpt so disconcerting. For a good deal of investors, there's a very real possibility of "selling low" when you see your share price drop 20%, 40%, 60% or if the dividend is dramatically reduced. It's just the psychology that's prevalent.

So to suggest that Wells Fargo held up better (and actually gained) during "economic troubles" without also highlighting the forthcoming trepidation and risks goes beyond "cherry picking" in my book. It's just misleading. When you see something that appears a bit too impressive (Wells Fargo was up when the market was down 37%?), it can be helpful to learn a bit more. Don't fall for the media's mumbo jumbo.

Disclosure: I am/we are long WFC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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