Is Wells Fargo Cheap Enough to Buy?

After coming out stronger post-recession, Wells Fargo (NYSE: WFC  ) is making some interesting moves. It surpassed its own record earnings of $3.8 billion from last quarter and is going for some smart acquisitions to strengthen its operations further. Therefore, I decided to take a closer look at this American banking giant to find out whether it deserves a place in my portfolio.

Solidifying operations
Wells has decided to acquire LaCrosse Global Fund Services, Cargill's hedge-fund administration and middle-office service provider. LaCrosse has valuable experience in providing hedge-fund administration services for a range of asset classes to onshore and offshore fund entities. It operates from places such as New York, Minneapolis, London, Dublin, and Singapore, among others. So this looks like a strategic purchase on Wells' part, as the acquisition will help spread out its hedge-fund business and the company will benefit from LaCrosse's expertise.

Performance
Wells is performing well on the earnings front as it witnesses some noticeable improvements in its credit quality. The last quarter witnessed a dip in negative credit metrics such as nonperforming assets and net loan charge-offs. They declined 15% to $27.9 billion, and 38% to $2.8 billion, respectively, on a year-over-year basis. It also recorded impressive growth in its net interest income and a fall in non-interest expense by growing its low-cost deposit base.

But as savvy investors, we need to look at earnings and beyond to decide whether a stock is worth investing in. Let's narrow things down by comparing the company with its closest peers along a few important parameters:

  • Price/earnings (P/E) ratio: This ratio helps us look at a company's earnings relative to its price and determine how cheap or expensive the stock is.
  • Price-to-book (P/B) ratio: Widely linked with value investing and a relevant metric for banks and other asset-heavy companies, P/B gives us a clear idea about a stock's valuation. It compares its market price with its intrinsic value and indicates opportunities.
  • Net charge-offs/total average loans: Reflects that part of the total loans which has been written off as uncollectible. High charge-offs often put a drag on earnings and question the ability of the bank to underwrite quality loans. Hence, investors want to see this metric as low as possible.
  • Tier 1 capital ratio: This metric, dividing the core equity capital by the bank's total risk-weighted assets, is a crucial ratio for measuring a bank's capital adequacy and its ability to stay afloat during bad times. It compares equity and reserves with total risk-weighted assets.

Take a look at the numbers to get a better understanding of how Wells Fargo fares in terms of valuation when compared with its peers.
 

Company

P/E

 

P/B

Net Charge-Offs/Total Average Loans

Tier 1 Capital Ratio

Wells Fargo 9.6 1.05 2.2% 11.7%
JPMorgan Chase (NYSE: JPM  ) 6.89 0.72 3.4% 12.4%
Bank of America (NYSE: BAC  ) NM 0.36 3.6% 11%
Citigroup (NYSE: C  ) 8.2 0.45 4.5% 13.6%

Source: Capital IQ, a Standard & Poor's company. NM = not meaningful.

A casual glance at the table makes Wells Fargo look less appealing than most of its competitors. Both P/E and P/B ratios are on the higher end (BoA's P/E cannot be quantified as it has been reporting consecutive losses). Wells' charge-offs is the lowest in the group, reflecting higher asset quality and its reputation for more conservative lending.

To get a better picture, however, I would like to compare Wells' current P/E with its historical averages. Wells has a five-year average P/E of 16.62 times. The current price could suggest that the market hasn't yet factored in the improvement in its credit quality discussed above. Considering this, the stock looks undervalued by historical standards. This might indicate an opportunity for investors.

The Foolish bottom line
It's always prudent to delve deeper. Stock valuation is an opportunity for taking a second look. Click here to add Wells Fargo to your Watchlist.

 Fool contributor Zeeshan Siddique does not own any of the stocks mentioned in the article. The Motley Fool owns shares of JPMorgan Chase, Bank of America, and Citigroup. The Fool owns shares of and has created a ratio put spread position on 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.


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