This High Quality Bank Is Still a Buy at All-time Highs
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Wells Fargo (NYSE: WFC) is on a tear lately; the stock has risen by more than 25% in the last year, and is now trading at new historical highs after reporting better than expected earnings last week. This doesn´t mean it´s too late to invest in the company though. This high quality institution has plenty of room to run in the long term.
Winners keep on winning
Investors sometimes tend to stay away from stocks that are rising strongly, especially when they are trading at historical highs. There is nothing wrong with being price conscious when building positions, but make no mistake investing is not about past performance. In fact, on many occasions, the best companies are precisely those that are making new record highs on a regular basis.
Think about some of the most successful investment stories of the last decade, companies like Amazon, Starbucks or Nike. They have many things in common, like high-quality management teams and strong competitive positions. Also, if we look at them from a historical perspective, they have reached new all-time highs on reiterated occasions on their way to delivering spectacular returns for investors.
The most successful companies usually perform well, so avoiding a stock only because it’s reaching new highs can be a really shortsighted approach, and it could lead to missing out some really outstanding investment opportunities.
Quality and valuation
Valuation is not about past price performance, a stock price needs to be compared against the company´s fundamentals in order to tell if it´s cheap or expensive. The rearview mirror can provide some valuable information, but what really matters is what's happening through the windshield.
Wells Fargo (NYSE: WFC) provides a great example about the importance of understanding the difference between a rising price and an expensive investment. Even if the bank is trading at historical highs, its price to book value ratio, a well accepted valuation metric for financials, is well below levels prior to the financial crisis.
What sets Wells Fargo apart from the competition is its high-quality management team with a simple and down to earth approach to the business. Under the leadership of John Stumpf, Wells Fargo avoided the mistakes made by competitors like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) during the credit bubble. Instead of taking undue risks trying to make easy money in the short term, Wells Fargo continued focusing on credit quality and long-term risk management.
This has provided the financial strength to continue expanding the business while its competitors were still trying to streamline their operations and balance sheets over the last years. Wells Fargo is now the undisputed leader in the US mortgage market; the bank originated a whopping $109 billion in mortgage loans in the first quarter of 2013, while former industry leader Bank of America and Citigroup originated only $24 billion and $18 billion, respectively.
Rising interest rates, if that is the case in the middle term, could negatively affect the mortgage business. However, the real estate sector still has a long way to go in terms of long-term recovery, and no company is better positioned than Wells Fargo to benefit from that trend.
Wells Fargo leaves its competitors in the dust when it comes to profitability too: it has a return on assets of 1.4% and return on equity of 13.6%. Bank of America in comparison has a ROA of 0.2% and ROE of 1.6% and Citigroup makes 0.4% in ROA and 4.4% in ROE.
The bank is more expensive than its peers when it comes to price to book value, although P/E and forward P/E look quite favorable for Wells Fargo considering its superior quality. Besides, it´s the only one in the group with an attractive dividend yield. In any case, a valuation premium for Wells Fargo versus Bank of America and Citigroup is clearly justified.
Wells Fargo is firing on all cylinders judging by financial results in the last quarter. Net income of $5.2 billion was a historical record for the company, and represented an increase of 20% versus the second quarter in 2012. Loans and deposits are also growing, and the bank enjoys a considerably lower percentage of delinquent loans than its peers.
If earnings are higher than ever, and perspectives are looking good over the middle and long term, the fact that the stock is at all-time highs should be no reason for concern.
Wells Fargo is stronger than ever, not only in terms of financial performance, but also when it comes to its strategic competitive position in the industry. The fact that the stock is trading at historical highs shouldn´t be a problem for investors since its valuation is still quite reasonable. Winners keep on winning, and Wells Fargo certainly looks like a winner.
Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!