The next selection for the Inflation-Protected Income Growth Portfolio is banking titan Wells Fargo (NYSE: WFC ) . One of the few major banks to have recovered its dividend to nearly its pre-financial-crisis level, and one that even noted value hunter Warren Buffett is willing to buy, Wells Fargo stands out for its strength.
It's true that the financial crisis did force Wells Fargo to cut its dividend, but that was due in large part to its acquisition of troubled bank Wachovia amid that crisis. The company's relatively quick recovery suggests that the blow was painful, but not fatal. So long as the company learned from that experience and stays away from buying severely troubled assets, it should be well positioned for the future.
Why it's worth owning in the iPIG Portfolio
To earn a spot in the portfolio, a company has to pass a series of tests related to its dividends, its balance sheet and valuation, and how it fits from a portfolio diversification perspective.
- Payment: The company's dividend currently sits at $1.20 a share, a yield of about 3% based on Thursday's closing price.
- Growth history: The company was one of the fastest major banks to significantly begin rebuilding its dividend after the financial crisis, with increases resuming in March 2011. Contrast that with Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) , neither of which have been able to take their dividends back above $0.01 yet, and Wells Fargo's strength becomes very clear.
- Reason to believe the growth can continue: With a payout ratio of around 28%, the company retains nearly three-quarters of its earnings to invest for future growth. That reasonable payout ratio is comforting given the banking crisis we just lived through and also gives the company flexibility to maintain its dividend if future growth doesn't materialize as quickly as hoped.
Balance sheet and valuation:
Balance sheet: A debt-to-equity ratio of around 1.2 indicates that the company does use debt, but it hasn't overleveraged itself to the point where a near-term financial hiccup would derail it. Indeed, for an industry that often relies on leverage to juice returns, that level looks remarkably reasonable.
Valuation: By a discounted earnings analysis that uses a 15% discount rate, the company looks to be worth around $226 billion. That makes its recent market cap of $212 billion seem reasonable.
The previous picks for the portfolio included:
- An industrial conglomerate
- A generic-pharmaceutical powerhouse
- A provider of staple foods
- An auto parts distributor
- A safety equipment provider
- A high-tech (software) titan
- A toy maker
- An electric utility
- A shipping company
- A pipeline giant (though this one might actually get away)
- A drugstore
- A semiconductor superstar
- A two-for-one railroad special
- A fast-food juggernaut
- A medical device maker
- A supplemental insurance writer
- An air chemicals business
- A defense contractor
- An industrial engineering and electrical equipment company
As the first bank to make its way into the portfolio, Wells Fargo fits pretty well from a diversification perspective.
Why pick it over its peers?
Still, as there are plenty of banks out there, it raises the question: Why select this one instead of another?
One of the biggest reasons is that, as mentioned above, neither Citigroup nor Bank of America has gotten its act together well enough to resume raising its dividend. While fellow banking giant JPMorgan Chase (NYSE: JPM ) has been able to boost its dividend back up out of the basement, JPMorgan also has held its dividend steady for the past five consecutive quarters. Contrast that with Wells Fargo, which was able to raise its dividend for its most recent payout, and Wells Fargo is signaling a far stronger position than those peers.
As the ability to pay and regularly raise dividends is a key feature of what makes a company worth owning for the iPIG portfolio, that's a significant plus for Wells Fargo.
What are the risks?
Of course, no investment is without risk. Another financial crisis or acquisition of overly damaged goods can force Wells Fargo to again slash its dividend -- or even worse. Additionally, as a California-based financial institution, Wells Fargo is at risk from that state's geology (earthquakes), wild swings in its housing market, and net outward migration from the state.
Additionally, banks are among the first to feel the impacts of shifts in Federal Reserve policy, as the Federal Reserve deals directly with banks. If and when the Fed starts easing up on the aggressive stimulus it has been pumping into the banking system in the past few years, Wells Fargo could feel some pain, along with the other banks.
What comes next?
When the Fool's disclosure policy allows, I plan to buy Wells Fargo's stock for the Inflation-Protected Income Growth portfolio, as long as it remains below $42.50 a share. I expect to invest around $1,500 in a 5% allocation in the portfolio, leaving 5% of the portfolio currently waiting on the stock that might get away.
Watch my article feed for news on the iPIG portfolio, and feel free to join the discussion on the iPIG portfolio's free message board, by clicking here. This Wells Fargo pick was suggested by a member of that message board who goes by the ID "kelbon." If you choose to participate on the board, you may be the one who suggests the stock that gets the iPIG portfolio to stop waiting on that elusive stock that might get away and instead put that cash to productive use.
Is there really such a think as a strong bank these days?
Many investors are scared about investing in big banking stocks after the crash, but the sector has one notable standout. In a sea of mismanaged and dangerous peers, it stands out as The Only Big Bank Built to Last. You can uncover the top pick that Warren Buffett loves in The Motley Fool's special report. It's free, so click here to access it now.