Banking on Banks

Austin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Bank of America (NYSE: BAC) has been on a wild upswing this year with a 54% increase in its share price. How does Bank of America compare to Wells Fargo (NYSE: WFC) and Citigroup (NYSE: C)? Where should your money go?

Share Price Change

The last year has seen solid gains for these three banks in their share price. Specifically, Bank of America has outperformed Wells Fargo and Citigroup with regards to share price alone. It is difficult to top a 54% return, so the stock price may already be tapped out. Citigroup, too, has had steady and wide increases, especially in the last 6 months.

 

<img src="/media/images/user_16267/screen-shot-2013-02-19-at-25512-pm_large.png" />

Wells Fargo has had a steady increase for the year. They have not had the wild swings Bank of America has had or smaller swings like Citigroup. Their gains have been consistent at a more manageable rate of 12.5%. 

The edge goes to Wells Fargo with steady gains.

Earnings Trend

Earnings per share for these three companies look very different with the exception that they are all outperforming pre-2009 levels.

<img src="/media/images/user_16267/screen-shot-2013-02-19-at-40604-pm_1_large.png" />
 

Bank of America has solidly risen from a loss in 2009 and 2010 to slight profitability in 2011 with $.01 per share in earnings. 2012 saw a giant increase to $.25 per share. The real issue comes down to next year and the years beyond. Analysts are expecting an increase of 390% in EPS next year and an additional 45% in 2014.

Citigroup has the wildest trend in EPS. In 2009 they lost a staggering $7.99 per share but were able to return to profitability with their competitors in 2010. But their earnings are trending down in 2012 while Bank of America and Wells Fargo are trending up.

Wells Fargo was profitable in 2009 while others were not. Their earnings have steadily increased in the last 4 years and are on track for another successful year.

Once again, the edge goes to Wells Fargo with steady increases in earnings over the last 4 years. 

The real question is what will the future earnings look like?

Earnings expectations put Wells Fargo's earnings at $3.64 per share through next year. This represents an 8% increase in their earnings from this year. The next four quarters will look a little different than the last four quarters when it comes to earnings.

<img src="/media/images/user_16267/screen-shot-2013-02-25-at-121526-pm_large.png" />

Wells Fargo has outperformed analyst's expectations by an average of 2% for each quarter over the last twelve months. With their earnings growth, their stock price target is between $38.77 and $39.59. Look for an approximate 10% increase in Wells Fargo's stock price in the coming months. 

Key Ratios of Management Effectiveness

Two very important indicators for the effectiveness of management in running a business are the return on assets and return on equity. These figures are for the most recent quarter.

<img src="/media/images/user_16267/screen-shot-2013-02-19-at-40619-pm_large.png" />
<img src="/media/images/user_16267/screen-shot-2013-02-19-at-40629-pm_large.png" />
 

Both of these managerial metrics follow a very similar pattern with Wells Fargo being 3 times as effective as Citigroup and Citigroup being twice as effective as Bank of America.

Once again, the edge goes to Wells Fargo. For every $1 of assets, management has delivered a return of 1.4%. For every $1 of equity they have delivered a return of 13.16%. This is quite the incentive to increase their assets and equity.

This means that as Wells Fargo increases their assets and equity, they have a history translating this in to earnings. They have been increasing their assets steadily over the last three years - especially their interest bearing loan assets. Their total assets have increased by an average of 4.43% with increases ranging from 1.16% to 8.3%.

Their assets are expected to increase by nearly 9% next year. This translates to an additional 1.17% earnings increase without any additional operational changes. This increase will help fuel the earnings growth of 8% next year. 

Dividend Discount Valuation

Trying to understand investor's expected growth rate is difficult. One way to do this is by reverse-engineering the dividend discount model to determine expected growth rate. Using a simple required rate of return of 11%, the company dividends and share price, the required growth rate can be calculated.

<img src="/media/images/user_16267/screen-shot-2013-02-19-at-40646-pm_large.png" />

<table> <tbody> <tr> <td><strong> </strong></td> <td> <p><strong>Dividend</strong></p> </td> <td> <p><strong>Share Price</strong></p> </td> <td> <p><strong>Assumed Growth Rate</strong></p> </td> </tr> <tr> <td> <p><strong>BAC</strong></p> </td> <td> <p> $0.04</p> </td> <td> <p> $12.03</p> </td> <td> <p>10.85%</p> </td> </tr> <tr> <td> <p><strong>WFC</strong></p> </td> <td> <p> $1.00</p> </td> <td> <p> $35.16</p> </td> <td> <p>8.34%</p> </td> </tr> <tr> <td> <p><strong>C</strong></p> </td> <td> <p> $0.04</p> </td> <td> <p> $43.84</p> </td> <td> <p>11.09%</p> </td> </tr> </tbody> </table>

Investors in Citgroup expect the highest growth rate with Bank of America close behind. 8.34% is more manageable than 11%. The edge, once again, goes to Wells Fargo due to investor expectations 

Wells Fargo seems to be the bank to be in. Their price trend has been less aggressive while their earnings trend has been steady and strong. They have the most manageable expected growth rate and the highest management effectiveness. They outperform Bank of America and Citigroup, for sure. 

The expected growth rate of Wells Fargo is on point with the expected earnings rate. Investors are in tune with Wells Fargo. While there has been an additional dip in the last day or so, Wells Fargo has a solid price target of $39.59.

 

Austin Higgins is the Principal Consultant for Build. Invest. Grow. and focuses on building businesses through innovation, growth and investment. Learn more at BuildInvestGrow.com and follow him on Twitter @Austin_Higgins


higginsaustin has no position in any stocks mentioned. The Motley Fool recommends 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!

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