Wells Fargo & Co Is at a 52-Week High: Here's Why It's Still a Great Bargain

Does Wells Fargo's underlying deposit-, loan and earnings growth justify a premium valuation?

Jun 9, 2014 at 7:15AM
Wells

Wells Fargo.

Since the beginning of the year, Wells Fargo's (NYSE:WFC) shares have performed the best in the large-cap banking sector. Shares of Wells Fargo have gained 15% year-to-date whereas shares of Bank of America (NYSE:BAC) lost 4% and shares of Citigroup (NYSE:C) 7%. With Wells Fargo edging from one 52-week high to the next, should investors still consider the $272 billion banking giant?

Loan and deposit growth
Wells Fargo's management team under leadership of Chairman and Chief Executive Officer John Stumpf has done an excellent job in recent years to increase the bank's profitability. While Bank of America's profitability was being dragged down by ongoing litigation issues and settlements resulting from its ill-advised acquisition of failing mortgage lender Countrywide Financial in 2008, Wells Fargo continued to press ahead.

Stumpf

John Stumpf. Source: Wells Fargo.

The profitability of a banking franchise with a large operations footprint is largely driven by deposit and loan growth.

While revenues and earnings from tailored investment banking advice fluctuate with the overall course of the economy, it is the bank's core operations, taking in deposits and making loans, that ultimately drives a bank's underlying profitability.

Over the last two years, Wells Fargo has had substantial success in attracting new deposits and growing its loan business. Since the first quarter of 2012 Wells Fargo reported loan growth of approximately 8% while its average deposits increased a whopping 18% billion to a total of $1.1 trillion.

Wells Fargo's first quarter 2014 results further highlighted that the bank continues to see strong growth in its core banking functions.

Strong underlying growth in Wells Fargo's core banking operations trickled all the way down to the bottom line. Wells Fargo's earnings stood at just $0.75 per diluted share in the first quarter of 2012 and now stand $1.05 in the first quarter of 2014 -- an increase of 40% over just eight quarters. 

Resilient business model
Wells Fargo operates a resilient business model that has been proven in a variety of economic environments.

Whether the financial industry was facing a bleak or buoyant earnings outlook, high or low interest rates, Wells Fargo managed to cope with the stormy sea a little bit better than its rivals.

Wells Fargo is also one of the few banks in the financial sector that rebounded both quickly and strongly after the financial crisis hit the U.S. economy in 2008.

Most importantly, Wells Fargo made it through the financial crisis without ever posting a yearly net loss; a solid indicator of both strong business stewardship and solid banking operations.

Book value premium
Wells Fargo is the only large-cap banking franchise that presently trades at a solid premium to its book value. With a current price to book ratio of 1.7x, Wells Fargo's market valuation miles ahead of its competitors. 

At the end of the day, better run banking firms should trade at higher earnings and book value multiples than companies that continue to face regulatory scrutiny and whose earnings picture is clouded due to high litigation and settlement costs.

While Wells Fargo clearly is one of the most expensive banking franchises in the industry, the bank has earned its spot due to one of the best performance records over the course of the financial crisis and due to healthy growth in loans, deposits and earnings.

With continued growth in the U.S. economy, which should lead to higher investment loan and mortgage demand, Wells Fargo's customer-centric business model is likely to see further tailwinds in the years ahead.

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Kingkarn Amjaroen owns shares of Bank of America. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup, and Wells Fargo and has the following options: short June 2014 $48 puts 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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