Shares of Wells Fargo (WFC) have just experienced their longest losing streak in more than eight years.
However, the stock is undervalued, and with earnings expected to increase, investors should take advantage and buy it.
To get a better picture of Wells Fargo's undervaluation and expected earnings increase, let's use a method used by one of the most successful investors of all time, Peter Lynch. He would create a chart that showed the stock price and earnings per share together and would then equate $1 in earnings per share to $15 in stock price.
The result allowed Lynch to get a better picture of whether a stock was undervalued or overvalued, and he used this to help him achieve superior gains.
Below is a chart for Wells Fargo, using his methodology with expected earnings.
Chart Courtesy of Gurufocus.com
Wells Fargo is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. See how Cramer rates the stock here. Want to be alerted before Cramer buys or sells WFC? Learn more now.
As the chart shows, Wells Fargo's stock price (green line) is trading well below its earnings (blue line), and with earnings expected to rise it will become an even more attractive investment.
Perhaps the best indication that Wells Fargo is undervalued is that it is trading below its Graham number of $49.12.
The "Graham number is a figure that measures a stock's fundamental value by taking into account the company's earnings per share and book value per share," according to Gurufocus. "The Graham number is the upper bound of the price range that a defensive investor should pay for the stock. According to the theory, any stock price below the Graham number is considered undervalued, and thus worth investing in,"
The Graham number is an extremely conservative valuation method, so the fact that Wells Fargo is trading below that number is a clear signal that the stock is cheap.
Other signs that point to Wells Fargo being a favorable investment are that its price-earnings ratio is near a three-year low, its price-book ratio is close to a three-year low and its dividend yield is near a three-year high.
Wells Fargo is also one of the largest positions in a number of prominent investor's portfolios, including Warren E. Buffet. On top of that, Director James H. Quigly made an insider buy on May 3 for 2,000 shares at $49.97, which is higher than the current stock price.
The company offers a top-quality bank stock, and investors would be wise to buy this drop as well as any future drops, hold their shares, get paid an attractive dividend and wait until the stock reaches its fair value.
This article is commentary by an independent contributor. At the time of publication, the author was long WFC.