Since June 2020, the S&P 500 has delivered a total return of 93.6%. But one standout stock has nearly doubled the market - over the past five years, Wells Fargo has surged 171% to $74.74 per share. Its momentum hasn’t stopped as it’s also gained 8.6% in the last six months, beating the S&P by 6.6%.
Is there a buying opportunity in Wells Fargo, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is Wells Fargo Not Exciting?
Despite the momentum, we don't have much confidence in Wells Fargo. Here are three reasons why WFC doesn't excite us and a stock we'd rather own.
1. Net Interest Income Points to Soft Demand
While banks generate revenue from multiple sources, investors view net interest income as the cornerstone - its predictable, recurring characteristics stand in sharp contrast to the volatility of non-interest income.
Wells Fargo’s net interest income has grown at a 5.8% annualized rate over the last four years, worse than the broader bank industry. Its growth was driven by an increase in its net interest margin, which represents how much a bank earns in relation to its outstanding loans, as its loan book shrank throughout that period.
2. Low Net Interest Margin Reveals Weak Loan Book Profitability
Net interest margin represents how much a bank earns in relation to its outstanding loans. It’s one of the most important metrics to track because it shows how a bank’s loans are performing and whether it has the ability to command higher premiums for its services.
Over the past two years, we can see that Wells Fargo’s net interest margin averaged a weak 2.8%, indicating the company has weak loan book economics.
3. High Interest Expenses Increase Risk
Leverage is core to the bank’s business model (loans funded by deposits) and to ensure their stability, regulators require certain levels of capital and liquidity, focusing on a bank’s Tier 1 capital ratio.
Tier 1 capital is the highest-quality capital that a bank holds, consisting primarily of common stock and retained earnings, but also physical gold. It serves as the primary cushion against losses and is the first line of defense in times of financial distress.
This capital is divided by risk-weighted assets to derive the Tier 1 capital ratio. Risk-weighted means that cash and US treasury securities are assigned little risk while unsecured consumer loans and equity investments get much higher risk weights, for example.
New regulation after the 2008 financial crisis requires that all banks must maintain a Tier 1 capital ratio greater than 4.5% On top of this, there are additional buffers based on scale, risk profile, and other regulatory classifications, so that at the end of the day, banks generally must maintain a 7-10% ratio at minimum.
Over the last two years, Wells Fargo has averaged a Tier 1 capital ratio of 12.6%, which is considered unsafe in the event of a black swan or if macro or market conditions suddenly deteriorate. For this reason alone, we will be crossing it off our shopping list.
Final Judgment
Wells Fargo isn’t a terrible business, but it doesn’t pass our bar. With its shares beating the market recently, the stock trades at 1.4× forward P/B (or $74.74 per share). This valuation tells us a lot of optimism is priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward our favorite semiconductor picks and shovels play.
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