Recently I was reviewing a bit of banking history and I came across an interesting piece. It was presented in October of 2007 and was called The World's Safest Banks 2007" - detailing 50 banks around the globe that this particular researcher felt were of the highest quality. Given the financial crisis that was to come, you can see why this commentary caught my attention.
Of the 50 banks mentioned, seven were based in the United States: #8 Wells Fargo (NYSE:WFC), #11 Citi (NYSE:C), #24 Bank of America (NYSE:BAC), #30 U.S. Bancorp (NYSE:USB), #35 Wachovia, #41 State Street (NYSE:STT) and #44 JPMorgan (NYSE:JPM).
After seeing this information, I thought it might be interesting to see how investors would have fared in the next eight years or so. It's conceivable that if you were investing in financial institutions during the time, these names would certainly top your list as potential partnership decisions. If someone had told you what was about to happen in the years to come you probably never would have invested, but of course you wouldn't have had this benefit of foresight.
So let's run down the list and see where you might be today. We'll start with equal investments in each security at the end of 2007, and see where it goes. The point is not to paint a particularly "rosy" or otherwise "downbeat" scene. Instead, it's about seeing what occurred and determining if some lessons can be had.
We'll start with Wells Fargo. At the end of 2007 shares of Wells Fargo were trading around $30. A $10,000 starting investment could have purchased about 331 shares. The company was paying a $0.31 quarterly dividend and had just earned around $2.40 per share. So your starting annual income would have been about $410 against an underlying earnings claim of roughly $790.
In the years to come the share price would decrease dramatically and the dividend was severely diminished. You can make an argument one of two ways: either an investor got discouraged and sold out or they stayed the course. For this article let's explore a long-term thesis instead of automatically presuming panic. For each scenario we'll suppose that you continued to reinvest the dividend payments along the way.
Some might argue that this is unrealistic, but I would counter that you would have had the opportunity to add fresh capital at lower prices in the future as well. Thus the "reinvestment only" option is a bit of a compromise; in-between panicking and boldly adding more as time went on.
Had you reinvested your dividends each quarter, today you would have accumulated about 410 total shares. The value of those shares would be about $20,000, with an underlying earnings claim of about $1,700 and an expected annual income of roughly $620. I find that to be a very good result, considering all that has happened.
Next up is Citi. This one doesn't turn out so well. A $10,000 starting investment would now be worth just $1,700. Your share count would have gone from about 34 to 37 and your underlying earnings claim would have not have been impacted all that much, but that's mostly because a good deal of the damage was already happening by the end of 2007. Your dividend income would have gone from quite solid, to basically nonexistent.
When you think about being risk averse to the banking industry, it's stories like these that make it easy to understand why. You had an incredibly profitable firm turn not profitable for a while and significantly dilute shareholders in the process. Still, that doesn't mean that investment can't work out moving forward.
In the third spot we had Bank of America, where a similar story can be told. A $10,000 starting investment would now be worth about $3,900, as investors saw their underlying earnings claim cut in half and the dividend now sitting at a tenth of what it was. I'll provide a summary at the end for comparison purposes.
In the fourth spot we have U.S. Bancorp - which gives off a bit more positive of a spin. A $10,000 starting investment would be worth about $15,700, as the company is earning more than it was per share prior to the crisis, despite the share count dilution that occurred. The per share dividend is still about 40% lower than it was as a result of a lower payout ratio, but an investor's income would "only" be about 25% lower than the previous mark.
Next up we have Wachovia, which looks like another bad news story. The information here is harder to discern as it was acquired by Wells Fargo during the crisis, but we can create a basic outline. At the end of 2007 shares of the bank were trading around $38, which would have allowed for the purchase of about 263 shares. Your underlying earnings claim would have started around $1,200 and you'd would have anticipated over $600 in annual dividend payments.
These factors didn't stick around for long. The company got into immense trouble and the share price reflected this. By the beginning of 2009, Wells Fargo had acquired Wachovia. Shareholders received 0.1991 shares of Wells for each Wachovia share that they had held. So your starting 263 shares would have turned into just 52 shares of Wells Fargo; at the time worth just $1,500 or so. (Note, this is not including the Wachovia dividends prior to the acquisition.)
Yet things did get a bit better. Those 52 shares would have turned into 62 shares, with a value closer to $3,000 today. Your underlying earnings claim and dividend payments would now be much lower, but you would still have a stake in Wells Fargo.
In the sixth spot is State Street. This is an interesting situation. A $10,000 starting investment would now be worth about $8,200; so from that prospective it isn't great news. Yet your share count would now be higher, as would your underlying earnings claim and dividend payments - both on an absolute and per share basis. The change in total worth has been more a reflection of valuation - moving from around 18 times earnings down to 12 - instead of long-term business performance.
Finally, we have JPMorgan as the last security on the list. This company gets a ton of flak, but the results have been quite reasonable over the long-term. You would have started with 229 shares and ended up with 278 shares. Your starting $10,000 value would now be worth around $17,400 and your underlying earnings claim and dividends would now be higher.
Here's a summary of all seven securities from the end of 2007 through April of 2016:
To be sure that's a wide range of outcomes, yet I think it's interesting nonetheless. Although all seven banks made the same "safest" list, you had a clear dispersion of results. Despite the short-term concerns during the recession, Wells Fargo, U.S. Bancorp and JPMorgan all have increased their underlying earnings power and shares are now worth more than prior to the recession.
On the other end of the spectrum you have Citi, Bank of America and Wachovia. These securities give you a fine example of what destroying the wealth building process looks like. Even if earnings materially improve, the original 2007 investment is apt to be under water for quite some time. However, I think there are a couple of takeaways.
For one thing it stresses the importance of diversification. If you just owned say Bank of America, your investment would now be materially lower. Yet if you elected to own both Bank of America and Wells Fargo, today you'd be sitting on a gain of about $3,900. Granted your income would still be lower, but the price at which you could sell and your underlying earnings claim would be higher.
Even better if you owned say Bank of America, Wells Fargo and 20 of your favorite dividend growth securities. I'm reminded of the old saying: "better to be owed $1 by 100 people instead of $100 by 1 person." Concentration in stock holdings can certainly work, but you ought to be mindful of the possibilities involved.
The second thing that is not illustrated is the ability to add new capital through time. The above depiction mostly demonstrates the idea of "one time investing." That is, deploying capital just once instead of many times as is ordinary practice for a good deal of investors. So as an example, while buying Bank of America at $40 would not have been optimal, that doesn't mean that you would then have been barred from adding more shares at $7 or adding to Wells Fargo at $20. A lot of people like to point out the "best" and "worst" times to invest, but often an ongoing long-term process is more realistic.
Finally, I'd consider State Street as somewhere in the middle in the above example. The company's earnings and dividends are now higher, but the share price is now lower due to the valuation. Which, incidentally, makes an interesting study in itself.
Your total starting investment would have been $70,000 and today's value is more or less the same. Although it's important to once again note the items discussed above: namely the benefit of diversification and the power of adding new capital that is not reflected.
At the beginning of the period, collectively those seven holdings had an average P/E ratio of just over 13 and a payout ratio of over 60%. Since that time, your total earnings claim would now be about 15% higher, moving from about $5,300 to over $6,000. Given the same share price, this means that today's collective P/E ratio is lower. Indeed, the mark today is closer to 11.5 or thereabouts.
Your $3,300 in starting dividend income would now be just $1,800 - surely bad news for the income investor. Yet for the long-term owner, this could bode well moving forward. Your earnings claim is now higher, but the collective payout ratio is now below 30%. The ability and safety of the payout is much improved, and in a few circumstances still higher than what it was.
Overall I find it interesting to review this sort of history. It gives you a context from which you can think about future investment decisions, and the takeaways are numerous. It's a real life of example of the good and bad that can come from a group lumped in together as being perceived as the "best" or "safest" at a given period of time.
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.