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Over the years, I've been informally taught to fear banks as investments. "Their balance sheets are too hard to read." "They're too opaque." My sister, a bank vice president with an MBA, even told me once to "steer very clear of them." But while this advice holds true for many banks, especially the ones on Wall Street, it doesn't hold true for all of them.
One of those exceptions is Wells Fargo (NYSE: WFC ) , a big bank that famously kept its nose clean during the financial crisis and just turned in rival-crushing fourth-quarter results. Let's take a step-by-step look at the 160-year-old banking stalwart and see just what makes it such a great investment for beginners.
First, some basics. In one form or another, banks have been around for millennia, and have traditionally made money in a very boring but dependable manner:
- Take in deposits.
- Lend the money out at a higher interest rate.
- Pay the depositors a lower interest rate.
- Pocket the difference between the two rates as profit.
Investment banking, as it evolved in the late 20th century, changed all this. Banks began making very exciting but risky investments, investments which could quickly lead to the bank's collapse if things didn't work out as planned. This is a large part of what happened in the 2008 financial crisis, with the now-bankrupt Lehman Brothers being a primary example.
Making money the old-fashioned way
Wells Fargo still makes money the old-fashioned way. It does have an investment arm, but to quote the bank's chief financial officer, Tim Sloan: "We like the investment banking business but we also like the fact that on a relative basis we don't have a specific business that's the majority driver." As such, Wells Fargo avoided much of the mess that engulfed the banking industry in 2008 (the effects of which are still being felt today).
In fact, with profits down across the investment banking sector right now, Wells Fargo's smaller investment banking arm meant smaller losses from that division in the fourth quarter, especially versus rival Citigroup (NYSE: C ) , which has a much bigger investment arm. Wells Fargo's net income for fourth-quarter 2011 was $4.1 billion, up from $3.4 billion in the fourth quarter 2010 -- a big jump of 20%.
Citigroup's fourth-quarter net income plunged 11%. The drop was due in part to a $163 million loss from the bank's investment arm, versus a profit of $212 million last year. Underlining just how tough things are in the investment banking world, fourth-quarter net income for JP Morgan Chase (NYSE: JPM ) dropped 16.3% year over year, with the mighty Goldman Sachs' (NYSE: GS ) net income plummeting a spectacular 57.6%.
Going global the old-fashioned way
Wells Fargo is the country's largest bank by market capitalization, and has earned its steady-Eddie reputation while doing most of its business in the U.S. But that's about to change -- at least to some degree. As its U.S. customers expand their business around the world, Wells Fargo plans on following them by moving into 20 foreign markets, including Germany, Hong Kong, the U.K., Japan, France, and China.
Expanding more globally is a good move for the big U.S.-focused bank, especially the way in which it's going about it -- that is, cautiously and thoughtfully. And the physical logistics of the move itself will be helped by the fact that Wells Fargo already has the office space, acquired when it took over Wachovia bank during the 2008 financial crisis.
The seal of approval
And, although I hesitate to mention it, another significant bright spot worth mentioning about Wells Fargo is that the bank is a favorite investment of Warren Buffett. Just last month, Buffett bought 46.6 million shares, bringing Berkshire Hathaway's (NYSE: BRK-B ) total holdings in the bank to 408 million shares, and accounting for 7.7% of Berkshire's total holdings.
They don't call Warren Buffett the Sage of Omaha for nothing. He's an extraordinarily careful, thoughtful investor. That said, you should never invest in a company just because someone else does, even if that someone else is Warren Buffett. But this 46.6 million share purchase is somewhat a seal of approval for Wells Fargo: It's not a deal breaker if it's not there, but it sure is nice to have.
Wells Fargo: One of the good guys
I hope you feel a little better about banks as investments now. They're not all shadowy, black holes. Sure, steady, profitably boring, and transparent -- the way all banks used to be -- wins the race in banking and investing -- and that's a formula Wells Fargo has down cold.
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