The Long-Term Case for Wells Fargo and U.S. Bancorp (Update 2)

Updated from 11:13 a.m. ET with market close information and comment from JPMorgan Chase analyst Vivek Juneja.

NEW YORK ( TheStreet) -- "Past performance does not guarantee future results."

How many times have you read or heard this irritating but accurate disclaimer?

It's true, of course, but when it comes to considering long-term investments in bank stocks, looking at past performance can be very useful. After all, the industry is still emerging from the earth-shattering crisis of 2008.

Earnings season for the nation's largest banks begins on Friday, with JPMorgan Chase ( JPM) and Wells Fargo ( WFC) scheduled to announce their first-quarter results before the market opens. Citigroup ( C) will report on April 15, and then Bank of America ( BAC) will round out the "big four" U.S. bank holding companies with its first-quarter earnings announcement on April 17.

So over the next two weeks, we will see breathless headlines saying whether or not the big banks have beaten quarterly earnings estimates. Then the sell-side analysts will make adjustments to their 2013 and 2014 earnings estimate and price targets. Most of the price targets have 12-month outlooks, with some analysts going out to 18 months.

The headlines are geared toward day-traders, and even the "long-term" price targets of the analysts are not for periods that have traditionally been considered long-term for the average investor.

Being a day-trader is wonderful, especially if you are a successful one. But for the average investor, a solid, truly long-term investment in a company with a consistently high return on equity can only bear fruit over a period of many years.

When we look at the big banks, while acknowledging that past performance cannot guarantee future results, the "past" for this industry has been pretty lousy, and good performance during the doldrums of the credit crisis can at least point to a comforting tradition for solid management.

According to data supplied by Thomson Reuters Bank Insight, Wells Fargo's return on average tangible common equity over the past five years has ranged from 7.15% to 16.95%. JPMorgan was the only other member of the big four club that also managed to achieve positive returns on tangible equity during that period, ranging from 6.55% to 14.92%.

Even if we leave out the "bad year" of 2008, a comparison of returns over the past four years for the big four, is striking:
  • Wells Fargo's annual returns on average tangible common equity over the past four years have ranged from 14.89% to 16.95%.
  • JPMorgan Chase's ROTCE has ranged from 10.66% to 14.92% over the past four years.
  • Citigroup's ROTCE has ranged from a negative 1.50% (in 2009) to a positive 8.61%, over the past four years.
  • Bank of America's ROTCE has ranged from a negative 1.62% (in 2010) to a positive 4.46%, over the past four years.

Only JPMorgan Chase comes close to Wells Fargo's performance among the big four, and it achieved a ROTCE of 14.92% in 2012 despite the "London Whale" hedge trading losses that came to at least $6.2 billion. But the company did face plenty of disruption in the wake of the trading losses, including the suspension of share buybacks in May 2012 and the recent grilling of current and former officers by the Senate Permanent Subcommittee on Investigations. The buybacks were resumed during the first quarter.

Wells Fargo has been able to achieve its strong performance despite more than doubling in size when it purchased the troubled Wachovia at the end of 2008.

Among the nation's banks, if we stick with the ones achieving double-digit returns on tangible equity over the past four years, U.S. Bancorp ( USB) of Minneapolis is the star performer, with ROTCE ranging from 14.18% to 22.39%. And during the crisis year of 2008, the company achieved a return on average tangible common equity of 23.09%.

Continued strong performance leads to eventual gains for investors, even though the banks have been forced to build up higher levels of capital in the wake of the credit crisis. The completion of this year's Federal Reserve stress tests led to regulatory approval for significant dividend increases and significant share buybacks for Wells Fargo, JPMorgan and U.S. Bancorp:
  • Wells Fargo was approved to raise its quarterly dividend to 30 cents a share in the second quarter from 25 cents, subject to approval by the company's board of directors. The 30-cent quarterly payout would equate to a dividend yield of 3.24%, based on Monday's closing price of $37.02. The company was also approved by the Fed for "a proposed increase in common stock repurchase activity for 2013 compared with 2012." Wells Fargo's share buybacks during 2012 totaled $3.9 billion.
  • JPMorgan Chase received only conditional approval for its 2013 capital plan, being forced by the Federal Reserve to submit a revised plan by the end of the third quarter. Nonetheless, the company was approved by the regulator to raise its quarterly dividend to 38 cents form 30 cents, making for a yield of 3.13%, based on Monday's closing price of $48.58. JPMorgan also received Federal Reserve approval for up to $6 billion in common-share buybacks through the first quarter of 2014.
  • U.S. Bancorp was approved by the Fed to raise its quarterly dividend to 23 cents a share from 19.5 cents. The shares have a dividend yield of 2.73%, based on the higher payout and Monday's closing price of $33.69. The company was also approved for share repurchases of up to $2.25 billion through the first quarter of 2014.

Significant buybacks, year after year, lead to a reduced share count and which lead to higher earnings-per-share, not to mention the higher earnings estimates among analysts, which push shares higher over the long haul. And those dividend yields are nothing to sneeze at, considering how low interest rates are.

A quick look at stock valuations for the five bank stocks mentioned here, shows that while Bank of America and Citigroup remain "bargain priced" at below tangible book value, the strong earnings performers don't trade much higher on a forward price-to-earnings basis:
  • Shares of Bank of America closed a $12.21 Monday, trading for 0.9 times tangible book value, according to Thomson Reuters Bank Insight, and for 9.3 times the consensus 2014 earnings estimate of $1.32 a share, among analysts polled by Thomson Reuters.
  • Citigroup closed at $43.56 Monday, trading for 0.8 times tangible book value, and for 8.4 times the consensus 2014 EPS estimate of $5.20.
  • JPMorgan's stock trades for 1.3 times tangible book value, and for 8.4 times the consensus 2014 EPS estimate of $5.82.
  • Wells Fargo trades for 1.7 times tangible book value, and for 9.6 times the consensus 2014 EPS estimate of $3.87.
  • USB trades for 2.5 times tangible book value, and for 10.3 times the consensus 2014 EPS estimate of $3.28.

So there you have it. You won't pay much of a premium, on a forward P/E basis, for the long-term stability of Wells Fargo and U.S. Bancorp. Even U.S. Bancorp, the "most expensive" among these five, and rightly so, in light of its fantastic earnings track record, looks cheap. Before the credit crisis, the stock easily traded above 20 times forward earnings.

JPMorgan Chase's stock also has attractive multiples, although the short-term uncertainty over the regulatory and political target on the company's back may give you pause, unless you have a strong stomach and can stick with the investment, despite the headlines.

First-quarter Concerns

The major headwinds heading into earnings season is the expected decline in mortgage loan origination fees, with a lower volume of refinancing activity, and reduced gains on the sale of newly originated loans to Fannie Mae ( FNMA) and Freddie Mac ( FMCC).

These are major short-term concerns for Wells Fargo, which currently dominates the U.S. mortgage market with a 25% share of origination volume. Then again, JPMorgan analyst Vivek Juneja on Friday made the case that improving loan servicing revenue and accounting adjustments will offset most of the company's mortgage revenue declines this year.

"We expect 1Q13 earnings to be relatively weak for the bank group, owing tosoft loan growth and a drop-off in mortgage banking. This poses risk for a pullback in bank stocks," according to BMO Capital Markets analyst Lana Chan.

In a note to clients on Tuesday, Chan included U.S. Bancorp among the banks she was "most concerned about," along with Comerica ( CMA) of Dallas and Cathay General Bancorp ( CATY) of Los Angeles.

BMO Capital Markets analyst Peter Winter rates both Wells Fargo and U.S. Bancorp "market perform," and on Tuesday raised his price target for Wells Fargo by two dollars to $42, and his target for U.S. Bancorp by a dollar to $37, which the firm said was "to reflect a switch in valuation methodology to forward P/E on 2014 estimates."

JPMorgan Chase analyst Vivek Juneja rates Wells Fargo "overweight," with a price target of $41.00. The analyst in a report said that his positive view of the shares was based on an attractive valuation, and also "due to 1) better fee income growth opportunities with recent acquisitions of loan portfolios, expansion of capital markets and wealth management businesses as well as leading mortgage banking position; 2) cost reduction plan; and 3) lower international risk and capital markets exposure relative to peers."

Juneja has a neutral rating on U.S. Bancorp, with a price target of $37.50, saying in the note on Tuesday that the rating is "due to our expectations for slower revenue growth, getting closer to peer revenue growth, as well as appropriate valuation."

On the other hand, Juneja wrote that "USB has a very diverse and strong array of businesses, strong management team, low cost efficiency, and lower impact from regulatory/political issues. As a result, USB has higher profitability which also drives greater share of EPS growth through share buybacks."

Wells Fargo's shares were up over 1% to close at $37.45, while U.S. Bancorp rose slightly to close at $33.69.

A "Core Holding" for Long-Term Investors

While being careful to say "this is not a trading call," KBW analyst Christopher Mutascio said in a note to clients on Tuesday that "Wells Fargo should continue to be a core holding for long-term investors."

According to Mutascio, Wells Fargo has achieved a compounded annual growth rate for tangible book value per share plus dividends, of 13.9% since the end of 2001. This compares to a median CAGR of just 0.4% for 11 large-cap bans covered by KBW.

Second-place for CAGR since the end of 2001 for tangible book value plus dividends goes to PNC Financial Services Group ( PNC), at 11.3%, with U.S. Bancorp in third place, with a CAGR of 8.3%.

When looking at share price performance over the same period, Wells Fargo was in first place, with shares rising 57% from the end of 2001 through 2012, while U.S. Bancorp placed second, with shares rising 53%. JPMorgan was ranked third, with shares rising 21%. PNC was a distant fourth, with shares rising just 4% for that 11-year period.

Then again, again, that's pretty decent performance for the period, considering the other seven big banks saw double digit losses. Fifth Third Bancorp brought up the rear, with shares falling 75% from the end of 201 through the end of 2012, according to KBW.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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