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Facing the Same Headwinds as Other Banks

November 19, 2013 | About:
In a previous article we saw that in the upcoming year I expect revenue growth for banks, despite the offsetting effect caused by high regulatory costs. Let's take a look now at two more banks and see which one is doing better and thus stands as the best investment.

After the Collapse

Bank of America Corporation (BAC) is the second-largest U.S. based financial holding company, with global assets of $2.1 trillion. It provides various banking and financial products and services.

The Company Recovery

The sale of non-core assets and branches that do not have sizable deposits or are not profitable operations becomes a good strategy for the firm. The bank had sold 118 branches in six deals, giving up $4.05 billion in deposits. Also, the bank is seeing smaller credit losses and the reduction in long-term debt which I expect to be good reasons for boosting earnings in the future.

A Larger Stake in the Bank

The management is returning good portions of its free cash flow to shareholders through share repurchases. The company obtained the approval from the Fed to repurchase up to $5 billion. This shows that the bank is well positioned to return excess capital, and we do not have to forget that buying back common shares is a good way to drive value to shareholders because it means fewer outstanding shares of the bank’s stock.

Valuation

In terms of valuation, the stock sells at a trailing P/E of 22.8x, trading at a premium compared to an average of 13.5x for the industry. Analysts’ expectations imply a forward P/E of 11.13. To use another metric, its price-to-book ratio of 0.73x indicates a discount versus the industry average of 1.04x and the price-to-sales ratio of 1.95x is below the industry average of 2.68x.

The Number “4”

Wells Fargo & Company (WFC) is the fourth largest bank in the U.S. with assets of nearly $1.5 trillion. Founded in 1852 and headquartered in San Francisco, it provides banking, insurance, investment, mortgage and consumer finance services.

A Large Number of Acquisitions

In late 2008, Wells Fargo acquired Wachovia, its major purchase. The bank issued 423 million common shares, with a value of $12.5 billion, to Wachovia shareholders. The purchase price of $23 billion and the fair value of net assets acquired of $14.3 billion, resulted in goodwill of almost $10 billion.

Fed Gives Approval

The bank has recovered its dividend to nearly its pre-financial-crisis level. Earlier this year, the dividend was increased by 14% and in April by 20% to $0.30. The bank also plans to repurchase more shares this year than last. The largest U.S. home lender repurchased shares for $43.7 million in the first six months of the year.

Its P/E multiple on a trailing 12-month basis is 11.5 and the forward P/E multiple is 10.86. The current dividend yield is 2.64%, which is quite good to protect the purchasing power and might attract investors.

Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.

Company ROE Compared to Industry Mean (=6.9)
Bank of America 1.8 Below
Wells Fargo 12 Above


While Wells Fargo ROE of 12% is above the industry mean of 6.9%, Bank of America's low ROE is not attractive. It is very important to understand this metric before investing in a high-growth company. The following graph shows the evolution of the ratio in the last 10 years. It can be seen that the ratio improves pretty well in the case of Wells Fargo.

982003088.jpg

Final Comment

While Bank of America plans to reduce the size of its branch network, Wells Fargo shares look attractive. The financial crisis did force Wells Fargo to cut its dividend, but now it is regaining pre-crisis levels.

For a long-term perspective, both banks are a buy, but I would advise fundamental investors to consider adding Wells Fargo to their portfolios, as it seems to be a more attractive option in general terms.

I think the investment is justified and hedge fund gurus like Ray Dalio, Steven Cohen and Jeremy Grantham added Wells Fargo stock to their portfolios. Should you too?

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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