This Bank Stock is Showing Some Signs of Life 🏦

With a new, externally-hired CEO at the helm that is serious about risk and compliance, Wells Fargo may now be a potential investment worth considering.

Once a favorite banking stock of Warren Buffett, Wells Fargo (NYSE: WFC) lost its spot in his portfolio after the bank suffered from a series of scandals. Things had gotten so bad at Wells Fargo that in 2018, the Federal Reserve actually restricted its ability to grow. Those restrictions are still in place -- and even the company itself doesn’t expect the caps to be lifted at least through the end of this year.

If there’s one thing that Wall Street doesn’t like, it’s restricted growth. Companies are generally valued based on investors’ expectations for their future, and the faster a company’s potential growth, the higher the premium its shares generally command. That restriction, along with the scandals that drove it, provides key reasons for why Wells Fargo’s shares are trading at less than they were five years ago.

Will tomorrow be better than today?
Of course, the key question for today’s potential investors is whether the company has cleaned up its act enough to where it can resume operating more independently. On that front, Wells Fargo is showing some signs of life. For instance, it bought back over 86 million shares of its stock in the first quarter of 2023, and it expects to be able to boost its dividend by nearly 17% later this year. 

If you add together the stock buyback and the expected increasing dividend, you have a path to some level of positive potential shareholder returns. After all, the same total earnings spread across a lower share count does add up to a higher per share earnings number. Plus, a growing dividend directly puts more money in shareholders’ pockets.

In addition, the company has spent billions recently settling lawsuits and in penalties and restitution for its past problematic business practices. While settling those cases doesn’t guarantee that the company will be allowed to resume growing, it’s at least a major set of obligations behind it. 

What are investors getting for the risks they’re taking?
Thanks to that restricted growth and damaged reputation, Wells Fargo currently trades at around 9 times its projected forward earnings. Assuming its dividend increase goes through, it will be paying out $0.35 per share per quarter, or a solid yield of around 3.2%. It’s also trading at almost exactly its book value. 

Put all those factors together, and Wells Fargo looks like a stock that’s priced either about fairly for a no-real-growth future or like a potential bargain if the company is allowed to resume building its asset base. That looks great, but it also raises a question about what happens if the company continues to get itself into trouble through its own actions.

On that front, Wells Fargo brought in a new CEO from outside the company in October of 2019, Charles Scharf.  As an external hire, Scharf was not part of the culture that enabled the scandals at the company. In addition, he had a track record of driving strong risk and compliance management, which is critically important if the company wants to have a chance of truly cleaning up its act.

Indeed, in the company’s 2022 annual report, Scharf spent several pages of his CEO letter talking about the challenges that were in place when he took over and what he and his team is doing to address them. Importantly, the company has added around 10,000 people in its compliance arm and spent about $2 billion more on compliance in 2022 than in 2018 (when its scandals were raging).  

While all that investment in risk and compliance doesn’t guarantee that Wells Fargo will be squeaky clean in the future, it does make it more likely that issues will be caught sooner, while they’re smaller. That should go a long way towards preventing a repeat of the scandals that knocked the company down.

Net -- while all investing involves risk, today’s Wells Fargo certainly seems serious about addressing the company-specific issues that caused its fall from grace. That improvement, along with a stock price that looks reasonable even for a fairly stagnant future, makes it a potential investment worthy of consideration.

At the time of publication, Chuck Saletta owned shares of Wells Fargo and also had the following options positions open on Wells Fargo: Long Jan 2024 $50 Calls, Short Sep 2023 $52.50 Calls, Short Jan 2025 $37.50 Puts, Short Jan 2025 $47.50 Puts.

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