There are worse things than owning a quality well-run business that Wall Street knows is well-run, but it isn't often a source of major investment alpha. With that in mind, San Francisco-based Wells Fargo (NYSE:WFC) continues to look like a good core holding in banking but not necessarily a significant near-term market-beating opportunity.

Still Beating, But It's Getting Harder

In contrast to JPMorgan (NYSE:JPM), which has been logging a run of earnings misses, Wells Fargo continues to report better-than-expected results. There's a lot of adjustment that goes on with large bank earnings, though, and that gap between reported results and “core” results is getting pretty thin. All of the following numbers are reported on an adjusted basis, and it's worth mentioning that no two analysts or investors seem to make exactly the same adjustments.

Core results were fairly soft, in line with the reports of other large banks so far. Revenue fell 6% yoy and 2% from the prior quarter. Net interest income fell 2% sequentially as a modest increase in earning assets was offset by another decline in net interest margin (down 7bp to 3.20%). Fee income fell 3% sequentially as Wells Fargo saw a widely-expected large drop in mortgage-related fees, but less-expected weakness in trading, insurance and deposit service charges.

Expense control was okay, with the end result being a 6% decline in core pre-tax pre-provision earnings.

Loan Growth Is Crawling Along

Wells Fargo reported a sub-1% sequential growth rate in loans, with slightly better performance (above 1%) in commercial lending. This is still somewhat early in the reporting cycle, but it looks like smaller banks are gaining some share in lending. Pittsburgh-based PNC (NYSE:PNC) and Dallas-based Comerica (NYSE:CMA), neither of which are small but are smaller than Wells Fargo and JPMorgan, both reported better loan growth on a sequential basis. On the call, management sounded a little more optimistic about the prospects for stronger loan growth (particularly resi mortgages) throughout the rest of the year.

While the loan book isn't growing much, at least the bad debt isn't either. NPLs were down 6% for the quarter and the non-performing asset ratio (or NPA) improved 11bp, while the net charge-off ratio improved 6bp to 0.41%.

Strong And Diverse

One of the real positives to the Wells Fargo story is that this is a fairly diverse business with a strong core franchise and a good capital position. Wells Fargo came out of the recent Fed stress testing looking pretty good and given what the Fed has indicated about its preferred payout ratios for banks, the underlying earnings power for Wells Fargo may be on the order of $4.60 – well ahead of the $4.09 average estimate for 2014.

Keep in mind that this is one of the largest banks in the country. Only Charlotte, N.C.'s Bank of America (NYSE:BAC) and New York-based JPMorgan have larger branch networks and Wells Fargo ranks second in national deposit market share (between B of A and JPMorgan). To add some perspective, Wells Fargo has more than twice the deposit market share of #4 Citigroup (NYSE:C), based in New York, and more than three times the share of #5 U.S. Bancorp (NYSE:USB), based in Minneapolis. Bank of America also has a large insurance operation, a growing wealth management business, and relatively little of the volatile trading and underwriting operations that create so much earnings variability for JPMorgan, Citi, and B of A.

This is not to say that Wells Fargo has no challenges ahead. The company has roughly 30% share in mortgage banking and that is not likely to grow much further. At the same time, banks like PNC and Comerica are working hard to grow their businesses in many of the same markets that Wells Fargo considers important to its long-term plans. Wells Fargo also wants to expand its card business, but JPMorgan and Citi are unlikely to go down without a fight.

The abiding issue I have with Wells Fargo is valuation. An excess returns model based on a long-term ROE of 15% leads to a fair value of $52 today (with a 16% ROE estimate leading to a $55 target). Using the company's return on tangible common equity to calculate a “fair” multiple to tangible book, I come up with a multiple of nearly 2x, leading to a target of about $48.50. It's worth noting, though, that Wells Fargo is one of the strongest of the large banks in terms of return on tangible equity.

The Bottom Line

I don't see anything wrong with Wells Fargo or its stock; I just don't think it's priced to generate substantial returns above and beyond the market. That's no reason for long-term holders to sell today, though investors considering new investments in the banking sector may want to shop around a bit more.

Disclosure – The author owns shares of JPMorgan.

Related Articles
  1. Retirement

    Tired Of Banks? Try A Credit Union

    These nonprofit organizations can provide a range of services for lower fees.
  2. Insurance

    Should You Buy Banks' "Toxic" Assets?

    The Public-Private Investment Progam is part of the government's effort to fix the failing financial sector. But is it a good investment?
  3. Savings

    Online Banks: Lower Costs And Little Sacrifice

    For many, online banking has become a day-to-day routine. Still, there are some holdouts who refuse to accept the method.
  4. Personal Finance

    The Pros And Cons Of Internet Banks

    Learn how internet banking services stack up against those of their brick-and-mortar peers.
  5. Options & Futures

    Lending Clubs: Better Than Banks?

    If you need to borrow money and your credit is making it tough, this new option may be just what you're looking for.
  6. Stock Analysis

    The 5 Best Alternatives to Zillow & Trulia

    Understand the online real estate industry and how Zillow and Trulia are industry leaders. Learn about alternatives to Zillow and Trulia.
  7. Stock Analysis

    How UPS Plans to Benefit from Its Coyote Acquisition

    Understand the business models of UPS and Coyote Logistics. Learn about the top four ways in which UPS will benefit from the acquisition of Coyote Logistics.
  8. Stock Analysis

    The 5 Best Buy-and-Hold Energy Stocks

    Understand why energy companies' stock are volatile when oil prices are volatile. Learn about the top five energy companies to buy and hold.
  9. Stock Analysis

    How Does Oscar Work and Make Money?

    Learn how startup Oscar is taking on the health insurance giants by offering customers free doctor's visits, generic drugs and 24-hour phone access to doctors.
  10. Stock Analysis

    Twitter Vs. Facebook Vs. Instagram: Who Is the Target Audience?

    Learn why Facebook, Twitter and Instagram each appeal to different target markets of the 1 billion users of social networks worldwide.
  1. Who decides to print money in Canada?

    In Canada, new money comes from two places: the Bank of Canada (BOC) and chartered banks such as the Toronto Dominion Bank ... Read Full Answer >>
  2. Who decides when to print money in India?

    The Reserve Bank of India, or RBI, manages currency in India. The bank's additional responsibilities include regulating the ... Read Full Answer >>
  3. What is the difference between a Debit Order and a Standard Order in a bank reconciliation?

    While both debit orders and standard orders represent recurring transactions that must be considered in bank reconciliations, ... Read Full Answer >>
  4. How can I cancel a bank draft that I have purchased?

    It is not commonly possible to cancel or stop payment on a bank draft since it, in effect, represents a transaction that ... Read Full Answer >>
  5. How does investment banking differ from commercial banking?

    Investment banking and commercial banking are two primary segments of the banking industry. Investment banks facilitate the ... Read Full Answer >>
  6. Who generally structures a syndicated loan?

    Typically, either an investment bank or a commercial bank structures a syndicated loan. A syndicated loan is provided by ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!