Charlie Munger is Warren E. Buffett's long-time, business partner and an excellent investor.
Munger's net worth is estimated at $1.28 billion. Buffett is known to concentrate his portfolio on his best ideas. Munger takes the idea of focusing on his best ideas to a new level.
The vice chairman of industrial conglomerate Berkshire Hathaway, has invested more than 67% of his stock portfolio in just one dividend growth stock, Wells Fargo (WFC) - Get Report . Such a large investment speaks to how confident Munger about in the banking giant's business model and future prospects.
This stock has a high 3.2% dividend yield and a price-to-earnings ratio of just 11.8. Additionally, it is one of Warren Buffett's highest yielding dividend stock holdings.
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Wells Fargo was founded in 1852 and is widely considered one of the bluest blue chip stocks.
It is easy to see why Munger has such a high regard for Wells Fargo. The company has proven its business model and success repeatedly over time. It is highly profitable, is the largest mortgage originator in the U.S., and has a reputation as a high quality brand in the banking industry.
Yet the market has not appreciated much of this. Investors are nervous about the continued low interest rate environment. The U.S. Federal Reserveraised rates in December for the first time in nearly a decade, but has delayed raising rates a second time in light of global economic uncertainty.
Slowing economic growth in the U.S. and abroad, the Brexit vote and the impending U.S. presidential election, have all raised uncertainty. This is problematic for banks, which are tied to the health of the economy and are sensitive to interest rates.
Wells Fargo needs higher interest rates to support growth. Banks generate significant profit from the spread between the interest they pay on short-term deposits, versus the interest they earn on longer-term loans like auto loans and mortgages.
In this ultra-low rate climate, banks' net interest margin is razor thin. That is why Wells Fargo's earnings per share declined 2% last quarter, year-over-year. Return on assets fell 10% last quarter because of persistently low interest rates.
If that weren't bad enough, Wells Fargo is getting hit by weakness in its oil and gas loan portfolio. There is a high level of uncertainty because of deteriorating loans to energy firms. This is in light of collapsing commodity prices over the past two years.
Last quarter, Wells Fargo absorbed $924 million in net charge-offs, an increase of $274 million from the same quarter last year.
All these headwinds have caused bank valuations to contract. Wells Fargo stock trades for a price-to-earnings ratio of just 11.8, which is less than half the S&P 500's price-to-earnings ratio of 25.
Wells Fargo stock has lost 9.9% of its value year-to-date, while the S&P 500 is up 7.3% in the same time.
This under-performance is disappointing for investors, but it could be an opportunity to buy into the stock and invest alongside Munger and Buffett.
Wells Fargo's growth has slowed, but could easily pick up again if interest rates rise. While the Fed has stayed put this year, it is widely expected that the central bank will hike rates by the end of 2016 or in early 2017.
Rising rates could be a catalyst for Wells Fargo, because higher rates could incentivize consumers to buy homes and take out mortgages. The pervasive sentiment is that interest rates will remain low, but a rate hike could provide the necessary shock to get cash off the sidelines.
That would set the stage for banking profit margins to widen, which will help increase Wells Fargo's earnings. And, a return to earnings growth could result in a higher price-to-earnings multiple, as well.
Rising rates will cause valuation multiples to decline for most stocks. Owning a business that's likely to benefit from rising rates helps investors diversify their portfolio against interest rate risk.
Meanwhile, investors receive a 3.2% dividend yield. Wells Fargo increased its dividend this year and will likely raise its dividend each year going forward. Wells Fargo passed the Fed's 2016 stress test with flying colors, and it is highly profitable.
Even in a difficult environment last year, Wells Fargo grew revenue by 2% and earnings per share by 1% last year. Wells Fargo brought in $23 billion of profit in 2015. This speaks to the strength of Wells Fargo's underlying business model.
Wells Fargo's current annual dividend is $1.52 per share, which equates to a 37% payout ratio based on the company's trailing 12-month earnings per share. This is a modest payout ratio, which gives Wells Fargo flexibility to continue raising the dividend and rewarding shareholders for their patience.
As a legendary value investor, Munger knows a good deal when he sees one, and Wells Fargo could be a great value now.
Wells Fargo is a great business. It also appears to be mis-priced and worthy of a large bet from Munger.
Wells Fargo's mix of value, dividends, safety and growth potential are likely why Munger placed the majority of his portfolio in Wells Fargo stock.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.