The One Financial I’m Buying Today
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
They were careless and greedy and because that they brought the world to its knees. They’d become too big to fail and when they began to fail it was like an epic game of dominoes where one’s fall toppled over its closest peer and there was seemingly nothing we could do about it. The system we’d known for our entire lives was about to become extinct, or so we thought.
Today the banking sector is still licking its wounds from nearly falling off the cliff into oblivion. Some like Bank of America (NYSE: BAC) are still hobbled by some of the decisions they made leading up to and during the crisis. Others like JPMorgan (NYSE: JPM) emerged stronger and more powerful than ever.
A third set of banks; those who’ve stayed away from the financial weapons of mass destruction that nearly blew apart the whole system are still being unfairly punished for the mistakes of their peers. These are banks like U.S. Bancorp (NYSE: USB) and Wells Fargo (NYSE: WFC) who have come through the crisis relatively unscathed and are now positioned to grow as the economy recovers. Of those two, the size and scale at Wells Fargo as well as their Buffett seal of approval make them the one bank I’m buying today and here’s why.
The Big Bank
The sheer numbers speak for themselves as they serve one in three American households through the largest retail branch network in the country. Looking at Wells Fargo another way, they are the number one mortgage originator and mortgage servicing portfolio as well as the number one small business lender and used car lender. They are the number two bank in deposits and the number two debit card issuer. Finally, they are the number three full-service retail broker and the number four wealth manager.
Of their peers, they are among the most well run bank in the nation. Take a look at this chart:
As you can see they have the lowest cost of deposits and earn higher fee income as a percentage of their assets which has enabled them to have the highest net interest margin. They’re second to U.S. Bancorp when it comes to both returns on assets and equity. Put it all together and you have an exceptionally well run bank that’s poised to continue to grow profitably for years to come.
Both the size and the operational excellence has drawn the attention of Berkshire Hathaway’s (NYSE: BRK-B) which owns $14.3 billion worth of Wells Fargo stock, equal to a 7.8% stake in the company. It is Warren Buffett’s favorite bank; in fact he said that he likes, “Wells better than anything by far…I like loading up on the one I like best.” That’s pretty good praise for the bank and just another of the great reasons for any investor to add the company to their portfolio.
It is also important to note that Buffett is no stranger to owning banks. In addition to Wells Fargo, Berkshire has a well-publicized $5 billion preferred share investment in Bank of America. He also has a decent size holding of U.S. Bancorp of about $2.2 billion which represents a 3.5% stake in the bank as well as smaller stakes in several other banks. Well Fargo however is his fourth largest holding and his stamp of approval just cannot be understated.
Financials and the Dividend
I mentioned earlier the conservatism of the management team at Wells Fargo. Not only do they run their lending business conservatively but they are very prudent in how they manage the balance sheet. Currently they are working to optimize their capital structure to meet Basel III capital requirements. Once they meet their target capital structure they believe they can achieve a return on equity of 12-15% depending on the rate environment.
Once that target capital structure is met they believe that their returns could support a total payout of 55-65%. They include both share repurchases and dividends so while they are currently paying out 29% of income as a dividend, that ratio won’t necessarily double from here. However, we should see a steady increase in their dividend over time.
None of this really matters if Wells Fargo is trading at an unappealing valuation. However, I think anywhere in the mid 30’s is a fair price to pay for Well Fargo. Shares are currently trading for about twelve times earnings or on par with that of the market. They’re projected to grow those earnings by about 10% annually for the next five years. That being said, being a big fan of earning income I want to earn some on Wells Fargo by writing an at-the-money put for my virtual “No Drip, No Mess” portfolio.
Specifically, I’m writing a single January $35 put which recently could be written for around $200 for a contract. That’s good for a near 6% yield on the cash set aside to keep the trade open. If come January I find that Wells Fargo is over $35 I can try and write another put depending on valuation. If shares are below $35 I’ll accept them gladly into the portfolio and collect their growing dividend. Also, in full disclose I’ll be writing these same puts in my personal account as soon as trading rules allow.
latimerburned has an option position in Bekshire Hathaway. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Berkshire Hathaway and Wells Fargo & Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.