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Wells Fargo Shows Why Investors Should Beware Scandal-Plagued Companies

By Al Lewis – Sep 11, 2021 at 7:15AM

Key Points

  • The shadow of Wells Fargo's phony accounts scandal still looms over the bank.
  • Investors are betting that better days lie ahead for the big bank.
  • But Wells Fargo's not fixing its problems fast enough to avoid regulators' wrath, and the stock could suffer for the foreseeable future.

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Five years later, the banking giant still hasn't yet recovered from its reputation-ruining fraud.

A plunging stock price amid a corporate scandal can sometimes offer investors a long-term buying opportunity -- but in the case of Wells Fargo (WFC 0.23%), the road to redemption looks long and bumpy.

The banking giant continues to be haunted by its phony account scandal of five years ago. Displeased with the bank's progress in compensating victims and tightening risk management and financial controls, regulators may add new sanctions that could hinder Wells Fargo's ongoing recovery, according to a recent report by Bloomberg News.  pleased with. 

Wells Fargo stock slumped more than 5% on the news and continues to languish. Lengthening the bad-news cycle, three former top Wells Fargo executives are slated for trial in a public administrative law hearing on Sept. 13 for their alleged roles in the scandal.

Two people use ATMs outside a bank.

Image source: Wells Fargo.

How much do scandals matter?

If markets cared deeply about banking scandals, just about every major bank would be in trouble. Since the 2008 financial crisis, most have settled allegations that could make the Mafia blush. 

Wells Fargo's biggest fraud was particularly brash and unnerving. Under pressure from their superiors, its employees signed up customers for credit accounts that they did not even know about, dinging credit scores and racking up unauthorized charges.

The Federal Reserve has since kept the bank in in a vise, imposing an asset cap that has limited its ability to grow its lending portfolio. That's why markets still care about Wells Fargo's transgressions. If the headlines don't improve, and regulators remain unsatisfied, that asset cap could remain in place for some time to come.

For the most part, though, memories are short and life goes on. That's one reason why company's stock is still worth holding for long-term investors, even though it may face some disappointments in the near-term.

A healthy post-pandemic run

From its pandemic low of $21.76, Wells Fargo has risen to a little over $44, even after the recent news of displeased regulators. That's about 33% below its all-time high of more than $60 in 2018, leaving plenty of room for improvement.

On the plus side, the banking giant is in the middle of a rapid stock repurchase plan that will support its stock price. It is also cutting costs and improving efficiencies to enhance profitability. And investors can still look forward to the day when the Federal Reserve lifts the asset cap, clearing the runway for takeoff.

What could go wrong? A relatively new Presidential administration could take a much harder approach to Wells Fargo's lingering scandals and its sluggish efforts to improve risk management and financial controls. This in turn could encourage the Fed to maintain its asset cap. Additionally, Wells Fargo could slip in its attempts to improve efficiencies and costs, or it could fall behind on its stock repurchase plan. An extended pandemic toll could also impact the bank's profitability by keeping interest rates low and slowing the economy.

Compared to other top U.S. banks, Wells Fargo is not a key player in capital markets, but it enjoys significant competitive advantages as the nation's fourth-largest bank. It boasts nearly $2 trillion in client assets and it operates a vast branch network that allows it to maintain a top position in many of its regional markets. 

Investors have been paying up for Wells Fargo stock, cheering its recovery. Its trailing 12-month price-to-earnings ratio hovers close to 12, compared to around 10.5 for JPMorgan Chase (JPM 0.19%) and roughly 7 for Citigroup (C 0.10%). Of the four largest banks, Bank of America (BAC 0.24%) has the top valuation, around 13.5. 

At these levels, it's difficult to argue Wells Fargo is undervalued, but investors are still betting that Wells Fargo's plans to improve efficiencies, buy back stock, and square its practices with regulators will justify its higher P/E.

Indeed, Wells Fargo still offers plenty of potential for long-term investors, including a 1.8% dividend yield that may see an increase, given management's propensity to support the stock price through its buyback program.

This, however, may not be the time to buy. Watch for additional negative headlines that could push the stock price lower in the weeks to come. And keep particular watch on any news on the Fed-imposed asset cap on the bank.

Fool contributor Al Lewis holds no financial position in any investments mentioned. Citigroup is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Wells Fargo Stock Quote
Wells Fargo
$47.44 (0.23%) $0.11
Bank of America Stock Quote
Bank of America
$37.70 (0.24%) $0.09
Citigroup Stock Quote
$48.29 (0.10%) $0.05
JPMorgan Chase Stock Quote
JPMorgan Chase
$136.74 (0.19%) $0.26

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