Buffett Boosts Stake in Wells Fargo… Again

It’s no big secret that Wells Fargo is one of the biggest holdings in Berkshire Hathaway’s portfolio at this time. Warren Buffett has once again increased his stake in the company, and the total Berkshire Hathaway investment in Wells Fargo is now about $19 billion. Over the last year, the shares have generated returns in the neighborhood of 29%. This is 9% more than the S&P 500, but it is also 8% less than the KBW Bank Index.

In case you’re wondering, the KBW Bank Index is a composite index that consists of a total of 24 stocks in the banking sector, and it is typically used as the banking industry’s benchmark. Nonetheless, the price-to-book value ratio of 1.51 and the price to tangible book value ratio of 1.93 are both actually quite higher than the average of the stocks currently part of the KBW Bank Index. This article plans to address the issue at hand of whether the current stock price has any room for growth.

When first looking at Wells Fargo, initially it looks like there is more room for growth and improvement. The current median target price of most analysts is $45 a share, and the mean target price is speculated at $45.93. The high benchmark is set at $54 per share, and the low is expected around $39 per share. At the time of this writing, the shares trade for around $41. Besides discussing the comparison, we also have a need to further investigate the potential growth prospects of this bank.

WFC Second Quarter Finances

During the second quarter, the bank reported a record net income for this quarter, and the company highlights are as follows: $5.5 billion net income – this is up 19%. An EPS at $0.98 per share – this is up 20% from the previous year. The reported company revenue during the quarter was $21.4 billion – this increased by $89 million. Non-interest expenses of $12.3 billion are down $142 million from the same quarter during the previous year. The company efficiency ratio improved from 58.2% down to 57.3%, and return on average assets of 1.55% is up 14 basis points. Return on equity of 14.02% has risen 116 basis points – this is all compared to the second quarter of the previous year.

Quarter end loans were $802 billion, and this is up by $26.8 billion. The Quarter end core deposits were $941.2 billion, and this is up by $59 billion. Capital also grew during the second quarter, and Tier 1 common equity of $117.6 billion under Basel I amounted to 10.73% of risk-weighted assets, and you can compare 10.08% to the previous year and 10.39% to the first quarter of 2013. Under Basel III capital rules that are in effect since July 2, 2013, they estimated the Tier 1 common equity ratio at 8.54%.

Operating Initiatives

American Express and Wells Fargo announced a partnership where Wells Fargo will be able to issue new credit cards that will be accepted as part of the American Express network. At the time of this writing, the financial terms have not been disclosed. Wells Fargo tells us that this move was in line with a strategy that they have to expand their credit card business plus they want to offer their customers a choice in variety of credit cards. The company plans to run a pilot program in a select number of US markets beginning in the third quarter of 2013, and initiated a full-scale launch during the first half of 2014. This allows Wells Fargo the opportunity to open their door on expanded income streams from the credit card business. At the time of this writing, only one third of the Wells Fargo customers own a Visa credit card. This means they have plenty of room to expand the company credit card offerings. Also, the average American Express card spend is $15,000 per year. The average Visa card spend is only $1000 per year. Wells Fargo will certainly capitalize on the increased spend.

Wells Fargo is currently the biggest player in the United States in the mortgage business, but it’s going to undergo some changes in the near future. First of all, the company is planning to withdraw from his eight joint ventures because regulations are increasingly making it more difficult to continue operating as a joint venture partnership. The company continues to stay on top of its staff and costs, and it plans to cut 2300 jobs in the mortgage business because of the decline in refinance which was caused by an increase in long-term interest rates. From its peak in May, the Mortgage Bankers Association tells us that the Refinance Index has dropped 62%, and in the week ending August 16, mortgage rates dropped 4.6% from the week prior.

Asian Growth

Wells Fargo will continue to see growth in Asia because it plans to increase the amount of fund services clients in this sector of the world by around 20% each year. It currently has 20 clients receiving its fund services in Asia, and those clients are made up of private equity firms, traditional funds, hedge funds and hybrid funds. Asia presents a growing opportunity in the emerging markets which have certainly attracted many of the major banks, and it amounts for 15% of Wells Fargo’s global fund services at the present. The bank plans to enhance their operations in certain areas, one particular being Hong Kong, where it recognizes that there are great opportunities in the region. They plan to open an office there as well. The Hong Kong region is also seeing a major boom in bond sales which have totaled $1.8 trillion as of the beginning of 2012. Wells Fargo currently has 40 employees operating a division from Singapore.

What’s the Recommendation?

At this time, Wells Fargo currently has about two of the major ingredients that Warren Buffett looks for when he makes an investment. The first is the quality management, and the second is that the business model is not complicated. The company has resisted the excesses of their peers, by avoiding such complicated things as derivatives, and they withdrew from the subprime mortgage market long before the bust. As expected, being such a large size company, it does have legal problems, but they are very small when compared to its contemporaries.

We strongly believe that the current stock price undervalues the stock being that the PE ratio of 11.13 times and the return on equity of over 13% which is more than the industry average of 9.36%. This is an anchor stock in the Berkshire Hathaway portfolio, and that goes a long way. We recommend this as a buy and it belongs in your portfolio as well.