This megabank handily outperformed the S&P 500 in the first half. Here’s why it could keep doing it.
In general, the relatively high interest rate environment hasn’t been kind to banks, leading to compressed net interest margins. Plus, bank charge-off rates have increased significantly over the past year, and many fear a recession could lead to an even larger spike.
With that in mind, it might surprise you to learn that consumer-focused megabank Wells Fargo (WFC 0.63%) outperformed the S&P 500 by about nine percentage points in the first half of 2024.
To be fair, Wells Fargo isn’t the only bank stock that beat the S&P 500 in the first half of 2024. In fact, most big banks did, as the economy is proving to be more resilient than expected in the higher-rate environment, and banks rebounded after an extremely turbulent and uncertain 2023. However, Wells Fargo did even better than most other big bank stocks, outperforming both JPMorgan Chase and Bank of America so far this year.
Despite its outperformance, however, Wells Fargo still looks like an interesting stock for long-term investors. Here’s why the bank is still near the top of my watch list, even after this year’s gains.
Several potential catalysts
As the most consumer-facing of the big U.S. banks — meaning that it doesn’t focus much of its efforts on investment banking — Wells Fargo is particularly sensitive to interest rates and consumer spending activity. As a result of the rising-rate environment, Wells Fargo’s net interest margin has fallen by 39 basis points to 2.81% over the past four quarters. The simple explanation is that deposit costs have increased faster than the yields paid by Wells Fargo’s loan portfolio.
On the other hand, this also means that Wells Fargo should have a lot to gain as interest rates start to come down. The median expectation of the Federal Reserve policymakers is for a total of five quarter-percent rate cuts by the end of 2025, and this would likely be a positive catalyst for the bank.
Finally, while there is no guarantee, there’s a real possibility that Wells Fargo’s growth cap could be removed within the next couple of years. If you aren’t familiar, the Federal Reserve currently prohibits Wells Fargo from growing beyond $1.95 billion in total assets — and this has been in place for six years. This effectively prohibits Wells Fargo to invest freely in the growth of its consumer or wealth management businesses. If the cap is removed at some point in 2025, as management reportedly expects, it could lead to a multiyear period of accelerated growth for the bank.
Creating shareholder value
Wells Fargo has prioritized dividends and buybacks as methods to return as much capital as possible to investors, and this could help it drive value over time, especially if the economy strengthens.
Wells Fargo just announced a 14% increase in its dividend following solid results from the latest Federal Reserve stress test. While the bank doesn’t have a flawless dividend history by any definition (most banks were forced to temporarily cut their dividends in the financial crisis and COVID-19 uncertainty), management does a solid job of prioritizing dividends and buybacks as its income allows.
Buybacks have been where Wells Fargo has been most aggressive, a good indication that management thinks the stock is attractive. In fact, the number of outstanding shares has fallen by 21% over the past five years alone. This emphasis on dividends and buybacks should help drive total returns for years to come.
Think about it this way: If the stock yields about 2.7%, which it does as of this writing, and buys back about 4% of its shares in the typical year, as it has over the past five, it won’t take too much growth of the business to produce double-digit total returns over time.
It still looks rather cheap
Wells Fargo isn’t just outperforming this year. As I recently wrote, Wells Fargo has produced a total return of about 170% in just four years. But that doesn’t necessarily mean it’s an expensive stock. It still trades for a valuation of less than 12 times forward earnings, and for a price-to-book multiple of about 1.3 — significantly below where it was (about 1.6) before the aforementioned asset cap was put in place.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Matt Frankel has positions in Bank of America and Wells Fargo. The Motley Fool has positions in and recommends Bank of America and JPMorgan Chase. The Motley Fool has a disclosure policy.