Shares of Wells Fargo (NYSE:WFC) have fallen sharply since a majority of voters in the United Kingdom cast ballots last week in favor of separating from the European Union -- the so-called Brexit. They're now approaching their 52-week low of $44.50 a share. Should investors take advantage by buying shares of the nation's third biggest bank by assets?
Assuming you were thinking about investing in Wells Fargo in the first place, the answer may very well be yes. The objective of investing, after all, is to buy low and sell high. You can't do that when things are going great -- that's when stocks are expensive. "You pay a high price for a cheery consensus," says Warren Buffett.
The 85-year-old chairman and CEO of Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) would know. Berkshire is Wells Fargo's largest shareholder, holding 9.9% of the bank's outstanding common stock. Buffett bought the stake in 1989 and 1990, just as analysts and commentators began to question whether the California-based bank would survive a severe downturn in commercial real estate.
How has the investment performed? Berkshire paid $290 million for its shares. Today, they're worth $23 billion. The dividends on the holding alone add up to more than $700 million a year.
To be clear, even though Wells Fargo's shares have dropped over the past week, they are by no means as cheap as they were when Buffett bought into the bank 26 years ago. Its shares were trading for only five times earnings at the time. Today, by contrast, they trade for more than twice that -- or 11 times earnings.
But even though that's a higher valuation than Buffett paid, I believe that Wells Fargo's shares are reasonably priced. I say that for two reasons. First, the average stock on the S&P 500 trades for 24 times earnings, or more than double Wells Fargo's valuation. Second, its shares yield 3.3%, which similarly exceeds the S&P 500. The average yield on the large cap index is 2.2%.
Now, there are reasons that Wells Fargo's shares trade at a lower multiple to its earnings compared to other large cap stocks. Increased regulations in the bank industry are clamping down on it profitability. Its return on average common equity last year was 12.7%. That was down from 13.4% in 2014, which was lower than the 13.9% it returned in 2013.
Wells Fargo has reduced its profitability guidance for the current year as well. At its 2016 investors day last month, CFO John Shewsberry said that the bank expects to generate a return on equity of between 11% to 14% this year. That's down from its previous range of 12% to 15%.
Wells Fargo is also a larger company than most of the other companies on the S&P 500. It's the 11th largest based on market capitalization, and the largest U.S. bank by this measure. Its sheer size alone thus makes it harder for Wells Fargo to grow as quickly as smaller companies.
But what you give up in terms of growth potential, you gain in stability. Wells Fargo proved during the financial crisis that it's one of the most conservatively run banks in the country -- never once reporting an annual loss through the worst economic downturn since the Great Depression. Since then, moreover, while many of its peers have struggled to generate consistent and respectable profitability, Wells Fargo's bottom line has consistently grown in absolute terms (i.e., not relative to its equity) thanks to a combination of bolt-on acquisitions and organic growth.
The net result is that Wells Fargo has one of the lowest betas in the bank industry, at 0.92, according to YCharts.com. This means that its shares are 8% less volatile than the broader market on a typical day. By comparison, Bank of America's beta is 1.76, JPMorgan Chase's is 1.63, and Citigroup's is 1.97 -- meaning that they're 76%, 63%, and 97% more volatile, respectively, than the average stock on an ordinary day.
Wells Fargo is likely to continue increasing its dividend, too. It already pays out more than a third of its earnings to shareholders each year, which will limit the size of a dividend raise, but it has demonstrated over the years that raising its payout annually is a priority. We'll find out this week, in fact, if this is the case. On Wednesday, the Federal Reserve will announce the results of the comprehensive capital analysis and review, in which the central bank has veto power over bank capital plans.
Taken together, then, if you were thinking about buying Wells Fargo's stock before the Brexit vote caused its shares to fall, then the case for doing so seems stronger today. This isn't to say the Brexit won't affect Wells Fargo, because it will. But rather, the impact is likely to be short term, just as it was in 1989 and 1990, when Buffett staked his claim in the now $1.85 trillion bank.
John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Wells Fargo. The Motley Fool recommends Bank of America. 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.