Profiling Buffett's Favorite Bank, Wells Fargo

| About: Wells Fargo (WFC)

Berkshire Hathaway (NYSE:BRK.A) CEO and Chairman Warren Buffett has stated many times that his favorite bank, if not his favorite company overall, is Wells Fargo (NYSE:WFC). Not only has he talked the talk, he's also bought a massive stake of its stock over a number of years for his company. Now the bank is the second-largest common stock holding in Berkshire's portfolio, just slightly behind Coca-Cola (NYSE:KO) in value - and he's still buying more of it.

Wells Fargo was founded in 1852 in San Francisco by Henry Wells and William Fargo to serve the banking needs of the West. Among other means, they used six-horse stagecoaches to send their money orders and other deliverables to the recipients as fast as possible. The iconic stagecoach still embodies Wells Fargo in its logos as the company has grown to become a leading nationwide bank.

As stated by Buffett and others, Wells Fargo's business is relatively easy to understand, compared to many other banks dealing with the volatile business of investment banking and/or trading and selling complex derivatives. Wells Fargo derives most of its revenue from loans, mortgages and service fees. Wells is also predominantly a U.S. business, whereas the other Big Four banks are much more exposed to the perils of Europe and other overseas markets. Below is a pie-chart showing the sources of Wells Fargo's total revenue (before interest expenses) for fiscal year 2011. Dollars in millions. Data source: their latest annual report.

Wells Fargo sources of total revenue for FY 2011
(Click to enlarge)

As illustrated, Wells is all about plain and simple banking. Loans and mortgages form more than 50% of their revenue. This recent Forbes article details the bank's efforts to understand their vast customer base better, in order to sell them more. Cross-selling is an important point of focus for the company - selling more of their products to more of their existing customers. They aspire to become the number one provider of all things financial - from insurance to asset management. They already do business with one of every three households in the U.S., giving the company an extensive amount of data that they're now probing to find more uncovered demand.

With this simple business model, Wells Fargo has been doing well amid the recession, and as a major mortgage lender it should do even better as the U.S. housing market is presumed to start picking up. Below is a comparison table of Wells and the other Big Four banks in terms of some of their key profitability ratios and valuation metrics. ROA, ROE and Tier 1 figures are from each company's latest annual report, representing FY 2011. P/E, P/B and dividend yields are calculated with stock prices as of today, and trailing 12 month earnings.

Wells Fargo JPMorgan Chase (NYSE:JPM) Bank of America (NYSE:BAC) Citigroup (NYSE:C)
Return on Assets, % 1.25 0.9 0.06 0.58
Return on Equity, % 11.93 11 0.96 6.5
Tier 1 capital ratio 11.3 12.3 12.4 13.6
P/E 11.25 8.6 9 8.5
P/B 1.3 0.8 0.4 0.5
Dividend yield, % 2.59 3.23 0.49 0.13

This is not exactly an apples-to-apples comparison, but it goes to show that Wells Fargo (along with JPM) is doing well compared to its big bank peers. Their simple modus operandi has spared them from the fouls some of the other banks fell for during the boom years. Wells' returns are healthy for the time being, but so is their valuation, at least compared to its peers. However, Buffett seems to think WFC is still a good deal at current prices and keeps buying it. What do you think?

Disclosure: I am 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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