Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
The new year is almost upon us, and a new tax law has just been passed in Congress and signed by the president. It's time to buy some bank stocks -- or so says Wall Street.
This morning, analysts at Buckingham Research announced they are upgrading shares of Wells Fargo (NYSE:WFC) and JPMorgan Chase (NYSE:JPM). Both of these bank stocks are receiving new buy ratings. Wells Fargo's price target goes to $75 a share (a 31.5% hike), while JPMorgan Chase's target goes up 35% to $135 a share.
At the same time, at Wedbush Securities they've added a third banking stock to the list -- this time a regional bank, Regions Financial (NYSE:RF). Regions gets an outperform rating (similar to buy) and a price target of $20, up 25% from Wedbush's previous target of $16.
So three bank stocks, all with just one opinion behind them: Buy. But which of these stocks should you consider buying first?
Weighing Wells Fargo
Let's begin at the top with Buckingham's pick of Wells Fargo to outperform. As explained in a write-up on TheFly.com today, the analyst's positive opinion of Wells Fargo depends on three primary factors. First and foremost, Buckingham believes that Wells Fargo will benefit from sizable earnings leverage from Congress' move to cut the corporate tax rate from 35% to 21%.
Granted, not all corporations were paying 35% even before tax reform passed in Congress -- but some were still paying a lot. Last year, S&P Global Market Intelligence data show Wells Fargo paid income taxes of $10.1 billion on pre-tax income of $32.1 billion -- a 31% tax rate. Cutting 10 percentage points off that rate should add about $3.2 billion in windfall profits to Wells Fargo's bottom-line profit (which was $21.9 billion last year), benefiting shareholders mightily.
And yet, Buckingham argues that despite the positive prospects, "expectations" are "low" for Wells Fargo going forward, while its valuation is attractive. S&P Global estimates show analysts projecting no more than a 7.7% annualized long-term growth rate for Wells Fargo. The tax reform windfall could grow Wells' annual profit by roughly 15% -- which equates to about 3% improvement in annual profits when spread out over five years, and suggests Wells Fargo's profits might now actually grow at nearly 11% annually over the next five years.
Combined with the stock's 2.1% dividend yield, that gives you a total return approaching 13% -- not bad for a stock selling for just 14 times trailing earnings.
Speaking of tax reform, Buckingham's argument in favor of buying JPMorgan Chase stock is similar: Tax reform will yield "'sizable' earnings leverage" to this bank's bottom line as well, reports TheFly.com. Share buybacks permitted by banking regulatory reform will further accelerate earnings growth. On top of all this, Buckingham views JPMorgan as the "best-in-class franchise" in banking, which makes the stock's 13.7 times earnings valuation even more attractive than the 14 times earnings cost of Wells Fargo stock.
But is Buckingham right to prefer JPMorgan Chase? I'm not so sure.
Start with the tax savings. In contrast to Wells Fargo's 31% tax rate, JPMorgan Chase paid only $9.8 billion in taxes last year -- just 28% of its $34.5 billion in pre-tax income. As such, a reduction in its tax rate to 21% would save only 7 percentage points, and add $2.4 billion to Chase's bottom line, boosting last year's net income of $24.7 billion to $27.1 billion -- a 10% improvement, or about 2% per year when spread over five years. Added to the 5% growth rate that analysts were already expecting from JPMorgan, that works out to 7% annual growth. Plus a 2.1% dividend yield, the total return on JPMorgan stock over the next five years might be 9% or so -- too low to justify even a valuation of 13.7 times earnings, in my view.
Wrapping up with Regions Financial
Last but not least, Wedbush Securities' pick: Regions Financial.
Rather than fixate on tax reform as Buckingham does, Wedbush outlines an argument for rising interest rates, cost cutting, and "capital optimization" positioning Regions stock for "above average earnings growth over the next two years." That's not to say that Regions will be totally left out in the cold by tax reform, however -- far from it.
Last year, Regions paid $514 million in taxes on $1.7 billion in pre-tax income -- a 31% tax rate similar to Wells Fargo's -- with a net profit of $1.2 billion. Cut 10 percentage points worth of taxes for Regions, and the bank's profits would grow by $167 million, bulking up the bottom line to more than $1.3 billion.
Take that 14% one-time increase in profits and average it over five years, and it adds just under 3 percentage points to the 11.8% growth rate that analysts were already expecting Regions to achieve -- putting the stock within spitting distance of a 15% growth rate. Now add a 2.1% dividend yield, and the total return on Regions stock could approach 17% annually over the next five years.
With Regions stock now selling for 16.4 times earnings, I'd argue this makes Regions the best bargain of the bunch. While I agree with the analysts that tax reform makes all three of these stocks more attractive today than they were as recently as Wednesday, if asked to rank the prospects, I'd say that Regions looks like the best bargain, Wells Fargo second, and JPMorgan last.