Wells Fargo May Prove Warren Buffett Right Again (Update 1)

Updated to reflect additional analyst comments and updated share prices

NEW YORK (TheStreet) -- When Wells Fargo(WFC) reports first-quarter earnings later in April it may resolve a lingering question about Warren Buffett's bank investing strategy: Has the "Oracle of Omaha" put his money behind America's most profitable bank?

Expectations are for Wells Fargo to possibly unseat JPMorgan Chase(JPM) as the most profitable U.S. bank by year end and solidify Buffett's next bank investing coup .

Going into first quarter earnings, investors are expecting big results out of Wells Fargo, after its record fourth quarter earnings outperformed rivals. The San Francisco-based bank saw its earnings grow nearly 30% in 2011, significantly beating the sub-10% earnings growth of competitors like JPMorgan and Citigroup(C), while Bank of America(BAC) swung from a 2010 loss to a moderate profit.

Wells Fargo is expected to earn $3.9 billion in first quarter profit on $20.3 billion in revenue, according to consensus estimates compiled by Bloomberg. For 2012, the nation's fourth largest bank by assets is expected to post a record $17.5 billion profit on $81.3 billion in revenue, which would put it in contest with the $18.5 billion in profit that JPMorgan is expected to earn.

While the profit gap with JPMorgan is expected to narrow next year, don't count Wells Fargo out in 2012. Momentum is on its side.

Wells Fargo shareholders, led by Buffett and his 7.28% share stake, have benefitted from the bank's faster growth expectations. In the past 12 months, Wells Fargo is the only "big four" bank to post share price gains, even after a 2012 financial sector share rally that's added over 20% to the KBW Bank Index(KBE). Since this time last year, Wells Fargo shares are up over 7%, while JPMorgan is just in the red and Citigroup and Bank of America continue to show deep losses from a 40%-plus 2011 share crash.

After stress tests results were reported by the Federal Reserve earlier in March, Wells Fargo led one of the most ambitious capital return and buyback programs, boosting its dividend by 83% and adding billions in share buybacks.

Starting in 2012, Buffett and other Wells Fargo investors could see a an annual rate of return near 18% driven by the company's improving profitability, according to Marty Mosby of Guggenheim Partners

While Wells Fargo shares trade at $34 -- below 2007 highs -- the company's earnings per share of $2.82 in 2011 eclipsed a previous pre-crisis high of $2.38. After a 2008 acquisition of Wachovia doubled the bank's revenue and earnings, Wells Fargo is expected to see continued growth. "[E]arnings levers could add almost $3 in earnings power to 2007 earnings per share of $2.38, more than double the level of earnings when the stock price peaked at around $37," notes Mosby in a Friday report. He rates shares a "buy," with a price target of $43.

In first quarter earnings, Wells Fargo is expected to show a strong combination of revenue growth and cost reductions, which could keep quarterly profits near record levels. Of the largest U.S. lenders, Wells Fargo also has the largest portion of its revenue tilted to the U.S. housing and mortgage market, which could recover with the broader economy in 2012.

"We see the bank benefiting from a recovery in the US economy and housing market," writes Richard Staite of Atlantic Equities in a March 23 note raising his price target on shares to $40 from $38, while maintaining an "outperform" rating.