By This Measure, Bank of America Is 5 Times Riskier Than Wells Fargo

The coefficient of variation underscores the point that Wells Fargo is a much better-run bank than Bank of America.

May 17, 2014 at 4:30PM
Mike Mayo

Mike Mayo. Source: CLSA.

There are multiple ways to measure how risky one bank stock is compared to another, but the one preferred by CLSA analyst Mike Mayo suggests that Bank of America (NYSE:BAC) is a whopping five times riskier than Wells Fargo (NYSE:WFC).

While the metric at issue has a complicated name -- the "coefficient of variation" -- its purpose is easy for anyone to understand.

"In the investing world, the coefficient of variation allows you to determine how much volatility (risk) you are assuming in comparison to the amount of return you can expect from your investment," explains Investopedia.com.

"In simple language, the lower the ratio of standard deviation to mean return, the better your risk-return trade-off."

Here's how it's calculated:

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In Mayo's case, because he wants to determine how volatile a selection of bank earning streams are, he divides the standard deviation of each bank's return on assets by the average return on assets over the period examined.

By comparing the result, one gets a quick and dirty idea about how volatile one bank's profitability is compared withto another, even if the banks being compared are dramatically different in size.

And remember, the lower the number, the less volatile.

Here's a selection of his results for the period from 2004 to 2013:

Bank

Coefficient of Variation (Core ROA)

M&T Bank

0.17

Wells Fargo

0.20

US Bancorp

0.24

PNC Financial

0.27

JPMorgan Chase

0.31

BB&T

0.39

Capital One Financial

0.53

Bank of America

0.98

SunTrust Banks

1.17

Citigroup

1.49

Source: CLSA Americas.

What this tells us is that M&T Bank's earnings were the least volatile of the group, with a coefficient of variation of 0.17. Wells Fargo was next with a coefficient of 0.2. Meanwhile, Bank of America's comes in at 0.98, or nearly five times that of Wells Fargo.

I trust this isn't an epiphany to many readers, as we've known for years, if not decades, that Wells Fargo is a demonstrably better-run operation than Bank of America. At the same time, looking at the issue from a different angle (and in black and white) is nevertheless a valuable exercise.

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John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo; owns shares of Bank of America, Capital One Financial, Citigroup, JPMorgan Chase, PNC Financial Services, and Wells Fargo; and has options on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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