Ride the Wells Fargo Stagecoach with Buffett

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Wells Fargo & Company (NYSE: WFC), a Berkshire Hathaway favorite, is well poised to benefit from economic recovery after posting strong financial results for 2012.  Taking note of this, Warren Buffett’s Berkshire Hathaway has recently added to its holdings of WFC, so that the stock now makes up 20 percent of its portfolio holdings.  Considering Wells Fargo’s improved prospects as the economic recovery gains momentum and housing continues to recover, other investors are also likely to benefit by investing in the stock.

Financial performance

For the fourth quarter Wells Fargo reported record net income of $5.1 billion, up 24 percent from the fourth quarter of 2011. This translates into earnings per share of $0.91, another record, and a gain of 25 percent from the 2011 fourth quarter.  Although the company’s revenue growth was not very robust, at 7 percent, the company’s move to be more efficient in controlling costs appears to be paying off.  For the entirety of 2012, Wells Fargo saw its net income rise to a record $18.9 billion, up 19 percent from 2011, with EPS gaining 19 percent too.

In early January 2013 Wells Fargo, as well as nine other major servicers, entered into a foreclosure review settlement with the government, in connection with which Wells Fargo incurred a $644 million charge in the fourth quarter.  Wells Fargo expects that it will not incur any costs in connection with government foreclosure reviews in the future, which is another positive going forward.

Economic improvement

As the economic recovery gained strength in 2012, Wells saw its credit losses decline to $9 billion in 2012, a 20 percent improvement from 2011 levels.  Wells also saw its portfolio quality go up overall as consumer delinquencies were down compared to 2011 and nonperforming assets were down 6 percent. 

As a result of the improved credit performance, the company did not see the need for $250 million of the reserves it had set aside to deal with loan losses, and this release also boosted the company’s fourth quarter performance.   Going forward, Wells also expects to release more of its loan loss reserves as the economy continues to improve.

And as mergers and acquisition activity starts to pick up with an improving economy, Wells Fargo could see its income from investment banking activities, which was up 30 percent in 2012 from 2011 levels, pick up further. In fact, Wells Fargo is providing financing for Berkshire Hathaway’s recent $28 billion deal to buy Heinz, thereby benefiting from Buffett’s interest in Wells Fargo. 

Avenues for growth

Another area in which Wells Fargo sees opportunities to grow is through cross-selling its financial products to its current customers. For instance, Wells could try to get a mortgage borrower to also open a bank account with Wells Fargo.  Considering that on average American households consume between 14 to 16 financial services products, Wells Fargo expects that it has considerable scope to grow in this area.

Although Wells Fargo has an international presence, it seems that the bank is more focused on generating growth from domestic operations, even as competitors such as JP Morgan Chase (NYSE: JPM) are gearing up to take more advantage of overseas growth. However, one overseas area Wells Fargo is currently looking to expand in is the U.K. commercial real estate lending market.

Competitive position

Comparing Wells Fargo to other major U.S banks, the company’s operating margin of 0.40 compares favorably to the industry average of 0.34, with JP Morgan’s operating margin at 0.36.  However, JP Morgan's EPS of $5.20 beats Wells Fargo’s EPS of $3.36 for 2012.  Still, Wells Fargo’s EPS beats Citigroup’s (NYSE: C) at $2.44, and Bank of America’s (NYSE: BAC) at $0.25. 

And at a price of $35.10, Wells Fargo’s price-to-earnings is 10.45 on a trailing basis, which compares favorably to Citigroup’s 17.71 and Bank of America’s 47.2. However, JP Morgan looks better with a P/E of 9.35.  

Take the ride

While Wells Fargo looks to be a good investment, it is still open to liabilities arising from loans made during the housing market boom, particularly the loans Wells Fargo owns from the bank’s acquisition of Wachovia.  And even after recent foreclosure-related settlements with the U.S. government, the bank could still be open to liabilities relating to abusive lending practices. Also, Wells Fargo expects that its mortgage lending volume will fall as opportunities for homeowners to refinance dwindle and originations don’t make up for the difference. 

However, the bank is always open to acquisition opportunities. And as part of its plan to return more capital to shareholders, Wells Fargo recently hiked up its quarterly dividend 14 percent to $0.25 per share, making for a dividend yield of 2.8 percent.  Thus, it seems that on the whole investors are likely to benefit by getting on the Wells Fargo stagecoach.

Poonka7 has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., 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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