Is This Old Buffett Favorite Now Worth Buying?
Once upon a time Wells Fargo was beloved by Warren Buffett. Despite scandal after scandal plaguing the company, his conviction couldn’t be shaken, until finally the accumulation of issues appeared to spark a sell.
As a reminder, here are the scandals that rocked Wells Fargo over the years:
- September 2016: The fake account scandal
- September 2016: Improperly repossessing service members’ cars
- December 2016: Wells Fargo fails its ‘living will’ test
- March 2017: More fake accounts
- March 2017: Flunked community lending test
- April 2017: Whistleblower wins $5.4 million and his job back
- August 2017: Lawsuit over overcharging small business retailers
- February 2018: Sacramento sues over discrimination against black and Latino borrowers
- March 2018: Wealth management investigation emerges
- April 2018: $1 billion settlement for mortgage locks and auto-loan issues
- May 2018: Altering business information without client knowledge
- May 2018: $480 million to settle securities-fraud lawsuit
- June 2018: SEC fine for leading investors astray
- July 2018: Refunds over add-ons like pet insurance and legal services
- August 2018: Hundreds of houses foreclosed on due to computer glitch
- August 2018: Wells Fargo pays $2.1 billion for its role in housing bubble
- March 2019: Wells Fargo among advisors sanctioned by SEC for fee-disclosure practices
Since Buffett offloaded his position, the company has made significant strides in its turnaround efforts and a recent reward to shareholders may finally make this old Berkshire stalwart worth buying again.
Key Points
- Wells Fargo, once a Buffett favorite, faced numerous scandals, including fake accounts and discrimination lawsuits, leading Buffett to ultimately sell his holdings.
- The consumer-focused bank beat earnings expectations but saw a sharp decline in net interest income due to rising funding costs and a shrinking loan portfolio.
- Wells Fargo increased its dividend by 14%, yielding 2.5%, and executed a significant share buyback.
It’s Not All Rosy But…
Wells Fargo managed to beat expectations on both the top and bottom lines in the second quarter but net interest income fell sharply to $11.92 billion, marking a 9% year-on-year decline and falling about $200 million short of analysts’ expectations.
The problem facing the top brass is that Wells Fargo’s cost of funding, which includes deposits and borrowing, has increased at a faster rate than the yields from its loan portfolio.
Worse still, the loan portfolio has contracted by about 3% over the past year because of a falloff in mortgage and auto loan demand. Mortgage originations, for instance, dropped from $7.7 billion in Q3 2023 to $5.3 billion.
It wasn’t all gloom and doom, though, with fee-based revenue rising, particularly in investment advisory fees, trading revenue, and investment banking fees. But it’s for another reason that investors may want to look more closely at Wells Fargo.
Reasons to Be Optimistic
While it’s not all sunshine and rainbows over at Wells Fargo, there are reasons to be optimistic. There are signs that the interest-rate headwind will dissipate soon. Rising rates have squeezed margins, but if rates fall as expected in the next few months and years, the situation may well improve significantly because Wells Fargo is the most consumer-focused of the U.S. large banks and so stands to benefit the most when rates fall.
What stands out to shareholders now, though, is the recent decision to hike the dividend by 14% to offer a 2.5% yield. Moreover, the Board decided a share buyback scheme would make sense given the valuation at this time and, in the first half of 2024 alone, spent $12 billion on repurchasing share, representing roughly 6% of its entire market capitalization.
Another important factor is the potential lifting of the Federal Reserve’s asset cap, which has been in place for years and prevents Wells Fargo from growing. Before the asset cap was implemented, the bank traded at an average of about 1.6x book value, but its current multiple is less than 1.3x. If the asset cap is lifted within the next couple of years, it has the very real potential to elevate the bank’s growth prospects and valuation.
The bottom line is this out-of-favor former Buffett favorite may finally be entering a period where the sun shines upon its shareholders again. Certainly the signs are pointing to better times ahead.
