Last week Wells Fargo (WFC) reported better than expected first quarter EPS of $0.55/share. If the company manages to maintain earnings at the current rate, the annual EPS would jump up to $2.20/share. That puts the forward P/E ratio at 9, which is pretty low, and makes the stock pretty attractive at current levels.
At the same time however Wells Fargo has cut its quarterly dividends from $0.34/share to $0.05/share. At the current stock price shareholders are getting a mere 1% yield. If things were really as great as the most recent quarterly report suggested, then the dividend should not have been cut so severely.
Dividends are typically real cash that companies pay out to their shareowners. Unlike earnings, which could be manipulated back and forth to show rosy sand castles, dividends are real cash that cannot be created out of thin air. Thus management commitment to a dividend policy of consistent increases shows confidence in the business model of the company and its ability to allocate cash flows effectively.
If the situation was that great at Wells Fargo, then the company doesn’t expect these record profits to be sustained over the course of the next few quarters, based off the severity of the dividend cut in March. Now some analysts would claim that the dividend cut was necessary in order for Wells Fargo either to have the cash to repay the treasury’s TARP money earlier, to maintain its Tangible Common Equity Ratio, or to conserve cash as financing is difficult to obtain during a credit crunch.
Even if management really believed that operating momentum is sustained and that annual earnings per share would grow at double-digit rates, unless the board decides to share the new prosperity with shareholders by raising the dividends or buying back stock, investors have few tangible options to profit from the prosperity. Of course stock prices could go higher if earnings go higher, but that’s not always the case. If you are betting on the greater fool theory to profit in the stock market however, you might join the crowd of 90% of active traders who consistently lose money. If you want to invest intelligently and not speculate blindly, you would pass Wells Fargo at this moment.
I do have high hopes for the company and would consider purchasing stock in it when the dividend growth policy is re-instituted. Until then there are many other opportunities for slow and steady total returns with much less risk considering.
Full Disclosure: None
Relevant Articles:
- The Dividend Edge
- Wells Fargo Joins the Crowd of Dividend Cutters
- TARP is bad for dividend investors
- Which Bank will be next? Follow the dividend cuts
- Best CD Rates
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With changes in how assets are reported and close to non existent interest rates, I'm not surprised they did make such a big unexpected profit.
ReplyDeleteI think most of the banks will be profitable or not as bad as what analysts expect.
I don't see why another surging rally wont be coming when financials report.
Wells Fargo, like it or not, is representative of banks in the current environment, which is practically unprecedented in the history of the country.
ReplyDeleteIn a nutshell, banks are--
--too big to fail (or not)
--receiving TARP money (or not)
--participating in the PPIP "toxic asset" program (or not)
--undergoing Geithner's "stress test" (or not)
--undercapitalized (or not)
--receiving second-level credit-default-swap money from AIG (or not), which of course is money provided by US taxpayers
--etc.
In the case of Wells Fargo, it is pretty clear that they are considered too big to fail, a survivor bank (thus the government-encouraged acquisition of Wachovia), butnevertheless teetering on the edge of sufficient capitalization.
Given all this, it was probably right and prudent for WFC to slash its dividend and preserve cash. That said, it will survive; it is pretty clear that the government will not let it fail.
Banks such as Wells Fargo have changed their "type" over the last few months: From Type D (reliable dividend-paying companies) to Type A (growth and speculative companies).
It is still quite unclear how the market will value such companies. They may be ten-baggers waiting to happen, courtesy (in part) of taxpayer money. Or they might be consigned to languish for years in a sort of zombie state, barely surviving, propped up by the government directly (TARP, PPIP, and other programs) or indirectly (receiving taxpayer money from AIG, the FDIC, or others).
One thing is clear: They are no longer reliable dividend stocks. They have entered a different world. It may be years before they become the reliable dividend-payers and raisers they once were. They may never return to that former status, as the whole US banking industry may undergo a massive paradigm shift into something we have never seen before.