As of the first quarter of this year, 132 different hedge funds owned over $5.1 billion of Wells Fargo (WFC -0.56%) stock. That makes Wells the fourth most owned financial stock on U.S. markets in terms of both the number of hedge funds invested and the total value owned by those hedge funds.
However, just because that many hedge funds have long positions in the bank doesn't mean that now is a good time to invest. In fact, over 50% of the hedge funds that owned Wells in the fourth quarter sold shares in Q1.
Selling pressure
Using publicly available data from regulatory reports, the analytical firm Novus compiled data on the largest and most influential hedge funds buying, selling, and holding long positions in U.S. stocks.
Based on that data, 144 hedge funds held long positions in Wells Fargo at the end of the fourth quarter. Of those, 71 reduced their position by selling shares, while an additional 21 exited their position entirely.
Year to date, Wells' stock price is up more than the S&P 500, but it trails the bank specific KBW Bank Index. Further, it has only been in the last few weeks that Wells' year to date performance caught up to and then surpassed the S&P 500. For the vast majority of 2015, the stock lagged the broader markets.
Fundamentally, Wells is a high-performing bank
It's hard to argue against Wells from an operating perspective. Consider that of the six largest bank holding companies in the U.S., Wells has the highest return on equity, the highest return on assets, and the second highest net income in the first quarter. It's also growing its assets at the fastest pace of this group of megabanks.
Per data from the FDIC's Quarterly Banking Profile, Wells Fargo produces results that are better than those of not only other large banks, but also the broader industry in general. The average return on assets for banks with more than $10 billion in total assets was 1.02% in the first quarter. Average return on equity was 9.12%, and the average efficiency ratio was 60.6%.
Contrast that with Wells' 1.38% return on assets, 13.17% return on equity, and 58.8% efficiency ratio for the same period. By nearly every signifcant measure, Wells beats out both its megabank competition and the rest of the industry.
The most likely reason hedge funds are selling Wells Fargo
Wells Fargo's strength is in some ways its biggest problem for many investors today. Wells has such strong operating numbers and such a great track record that the stock trades at a very high premium.
Wells today trades for 1.77 times book value. By conventional standards, a bank with a price to book value below 1 is considered cheap, while one with a ratio above 2 is considered expensive.
Over the past few years though, megabanks have traded lower than historical standards as the markets are pricing in the new and unclear regulatory costs of being "too big to fail" under Dodd-Frank and other new regulations. To account for this, we can compare Wells' valuation to other megabanks directly on where they have traded since the financial crisis.
Relative to these other large, "too big to fail" institutions, Wells' commands a ridiculous premium, 45% higher than the next highest valuation in terms of price to book value.
WFC Price to Book Value data by YCharts
It's important to keep in mind that many hedge funds seek to produce out-sized returns quarter after quarter. That means they aren't necessarily interested in the operating fundamentals driving a company -- they're more concerned with the potential for a stock to make big movements that produce big returns.
I think that it is this high valuation that has many hedge funds exiting the stock, taking profits, and redeploying their capital into other opportunities.
For hedge fund investors, Wells' high valuation means that the bank is unlikely to outperform the market in a significant way over the short and medium term. There just isn't much more room to run on the upside, regardless of how well the bank continues to perform fundamentally.
