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Is Wells Fargo a Buy While It's Down?

By Matthew Frankel, CFP® – Jun 2, 2020 at 6:03AM

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The scandal-plagued bank is trading at a ridiculous discount and could finally be worth a look.

Wells Fargo (WFC 1.95%) has been one of the biggest losers in the financial sector. Until a few years ago, Wells Fargo was widely regarded as being a top-notch financial institution, with profitability and efficiency that was consistently superior to its peer group.

In the past few years, however, numerous scandals have caused significant underperformance, and it has only become worse since the COVID-19 pandemic began. Now, with a new CEO, an overhauled corporate culture, and a rock-bottom valuation, could Wells Fargo finally be worth a look?

Exterior of a Wells Fargo banking branch.

Image source: Wells Fargo.

Wells Fargo was one of the financial sector's biggest losers before COVID-19

One important piece of information to know is that Wells Fargo has been one of the financial sector's worst performers, both before the pandemic and since it started.

The reason for the pre-coronavirus underperformance had been the bank's numerous scandals that have come to light in the past few years. It started in late 2016, when it was revealed that millions of fraudulent accounts were opened by more than 5,000 employees, mainly in an effort to meet aggressive sales targets set by the bank's leadership.

Over the subsequent months and years, several other scandals were reported. One big example was the 2017 revelation that 570,000 of Wells Fargo's auto loan customers may have been improperly charged for auto insurance. (Note: I happen to have been one of them.) As a result of these scandals, the Federal Reserve slapped Wells Fargo with an unprecedented penalty prohibiting growth -- and the 2017-2019 period was arguably the best growth environment for banks in decades thanks to the Tax Cuts and Jobs Act and general business-friendly regulatory environment.

As a result of the scandals and penalty, Wells Fargo only gained 8% from the date the fake accounts scandal was revealed in late 2016 through the end of 2019. That may not sound too bad, but the Financial Select Sector SPDR ETF (XLF 1.97%) gained 55% during that time.

2020 has amplified the underperformance

Through the end of May, Wells Fargo has lost 50% of its value -- far worse than the overall financial sector's 24% decline.

The short explanation is that banks that are primarily focused on commercial banking (as opposed to investment banking) have been the hardest hit in the bear market. There's tremendous uncertainty surrounding the potential for loan losses, especially if the recession ends up lasting longer than expected. All of the big U.S. banks have set aside billions to cover losses, including Wells Fargo.

Investment banking tends to perform quite well during turbulent market environments. This is why banks focused on the investment banking side of the business, like Goldman Sachs, are outperforming the overall financial sector, and why other big commercial banks like JPMorgan Chase and Bank of America -- both of which have large investment banking operations -- are holding up far better than commercial-focused bank stocks like Wells Fargo. Now, Wells Fargo has some investment banking activities, but the bulk of its revenue comes from its commercial lending operations.

In total, Wells Fargo has underperformed the financial sector by a staggering 65 percentage points since September 2016. Shares now trade for a remarkably low valuation of just 68% of their book value -- a level that hasn't been seen since the depths of the financial crisis in 2009.

Here's why Wells Fargo might be worth a look now

Aside from the cheap valuation itself, there are some good reasons you might want to take a look at Wells Fargo. For one, it has done an excellent job of changing its sales culture, as well as its leadership. Recently appointed CEO Charles Scharf was formerly CEO of Visa and has an excellent track record of effective leadership.

Furthermore, Wells Fargo has a long history of responsible lending and high asset quality, and this is one thing that hasn't changed. It was this focus on quality that allowed it to emerge from the financial crisis bigger and stronger than before thanks to its fire-sale acquisition of Wachovia that catapulted the bank into the big leagues. And aside from the recent build in its loss reserves, Wells Fargo is a rather profitable financial institution.

To be fair, Wells Fargo is certainly on the riskier side. If the effects of the recession end up being far worse than expected, the recent $3.1 billion reserve build may not be nearly enough. However, Wells Fargo is in strong financial shape to make it through the pandemic, and at the current valuation, patient investors with relatively high risk tolerance may do very well over the long run.

Matthew Frankel, CFP owns shares of Bank of America and Goldman Sachs. The Motley Fool owns shares of and recommends Visa. The Motley Fool has a disclosure policy.

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Wells Fargo & Company Stock Quote
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