- Wells Fargo is still increasing revenues despite the present profit margin headwinds. Its net interest income margin actually ticked up in Q2 of this year to 2.97%
- PE ratio is quite low as well as its price to book ratio. There are banks with cheaper price to book ratios but they don't have similar fundamentals
- I believe interest rates rising would reduce Wells Fargo's mortgage loan book. A hike could work in the bank's favor as house prices could drop which would bring more millennials to market
Wells Fargo (NYSE:WFC) and many other financial stocks were actually up year to date up to July but are down heavily since August (Well's Fargo 10%+). The reason being sentiment started to change with regard to the FED raising interest rates. We saw weakness starting to develop also with the US dollar in August and both (the dollar and Wells Fargo) have continued to sell off after the Fed's announcement (see chart).
Source: Google Finance
The sell off in Wells Fargo in my opinion gives legacy investors a fantastic opportunity. This bank currently pays out a yield very close to 3% and it has consistently raised its dividend for the past 5 years. Furthermore its latest Q2 earnings clearly illustrate that this bank is growing which is why I believe it will continue to raise its dividend irrespective of the interest rate environment it will be operating in..
Speaking of interest rates, this bank derives more than 50% of its income from its "Net Interest Margin" metric. Net interest margin is the difference between interest income received by the banks and interest paid out to customers usually on deposits or other interest bearing assets. Wells Fargo outperforms here compared to the overall sector. The average "NIM" actually grew for the first time in many quarters in Q2 of this year (1st rise in NIM since Q4-2011). It is still Wells Fargo & U.S. Bancorp (NYSE:USB) that set the pace with net interest margins among the big banks (2.97% and 3.03% respectively)
A few things came out of last quarter's earnings which also make me bullish on Wells Fargo stock. Firstly, existing home sales are now at 2007 levels which is bullish for mortgage lenders. Following on from this, borrowers are making good on their loans as the charge-off rate of loans fell last quarter. Wells Fargo has almost $900 billion of loans on its books and the up tick in mortgages definitely is affecting its bottom line. Last quarter, the bank had net income of $5.7 billion which illustrates good momentum as net income in the year ago quarter was also $5.7 billion.
What investors need to remember here (and why I say momentum above) is that the bank's NIM metric 12 months ago was 3.15% ($11.4 billion in "NIM" revenue ) which was a full 0.18% higher than present levels (2.97% & Income topping 11.5 billion) ( see NIM chartsbelow). This is where Wells Fargo has an advantage over smaller banks. By increasing volumes and cutting costs, the bank can increase its bottom line even if interest margins are falling. Moreover interest rates dont have any where else to go. They will undoudtely go up one day to counteract the huge easing programs that have been adopted by central banks over the last 7 years. This is why I see limited downside for Wells Fargo. With $1.2 trillion currently in deposits, you would feel this would only go up if investors got a better return on their money going forward.
Secondly, Wells Fargo stock currently trades at very attractive valuations. The current P/E ratio is 12.43 and the forward P/E is lesser at 11.42. Furthermore, the banks's price to book ratio is only 1.6 at the moment which is still very cheap when you consider the spike this company is achieving at the moment in loans and deposits growth (5% YOY and 8% respectively) (see chart)
The price to book ratio works well in this sector because banks traditionally have a lot of fixed assets ( branches, etc). Well as you can see from the chart, this bank currently has a price to book ratio lower than in the year 2000. Revenues 15 years ago were approximately $20 billion where as now they are $80 billion+. Even since the depths of the great recession in 2009, revenues have increased by more than $16 billion. The opportunity hasn't passed with this bank although the share price has rallied hard since 2009. Expect to see more gains when interest rates rise and as the bank continues to cut costs.
Bears will undoubtedly state that a pick up in interest rates will dampen activity in the mortgage market but personally I don't see that happening. Firstly, If the FED hikes, I only see it doing a 0.25 basis points hike. We are not going to an environment of increasing rates every quarter in the US even though all the metrics are positive. Unemployment remains at historic lows and retail spending increased again in August. I don't think mildly higher interest rates would deter prospective home owners from buying a house. Furthermore the demographics trend for housing in the US is bullish. Why? Well you have more than 83 million millennials in the US (out of a population of 318 million) who are now coming on either to rent or buy a house. Either way you look at it, demand is going to stay elevated because baby boomers are aso living longer meaning less and less second hand houses are coming to market. Higher interest rates have the potential to make prices come down which again would be good for Wells Fargo. More affordable homes may convert some millennials from renters to buyers.
To sum up, I think this bank looks very favorable as an investment at the moment. Increasing numbers of loans, deposits and less charge-offs have grown this company despite dealing with a low "NIM" metric for the past 5 years+. Long Wells Fargo stock from here.