Wells Fargo: Now a Buy
We've been avoiding most financial stocks, but now is the time to make an exception for this San Francisco-based banker.

In a market in which bad calls have been the norm, a call we got right was our decision last summer to avoid most financial stocks.
This was our reasoning as laid out in our September 2008 column: "Sadly, as bad as things have been, there's a strong case to be made that we've only seen the tip of the iceberg of housing- and mortgage-related problems, and that an enormous wave of home defaults, foreclosures and auctions is about to hit financial stocks."
As a result, we not only avoided most financials but also sold short some of those that were most exposed to the ongoing housing meltdown. Our best investments over the past six months, by far, have been in bearish bets on companies such as Wachovia, Washington Mutual and Wells Fargo.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Change of heart
We recount this history not to pat ourselves on the back, but to provide context for our reversal on Wells Fargo (symbol WFC), the San Francisco-based banking giant. In fact, it marks only the second time in our careers that the share price of a company we had shorted fell so precipitously that it became a bargain worth buying. (The other case was Canadian insurer Fairfax Financial, which we still own today.)
The thesis for shorting Wells in January rested on two pillars. First, we thought Wells was buying some giant loan losses, especially in option ARMs and home-equity lines of credit, when it acquired Wachovia last October. Second, at close to $30, Wells's stock traded at three times estimated tangible book value, which we viewed as too high given the ill health of mortgage and credit markets.
When the shares fell below $10 two months later, we saw a very different risk-reward scenario. That prompted us to change our position and buy the stock, even though we think there are still big losses to come on Wells's loans.
Wells is in a race for its life. The company has set aside $23 billion as a provision for loan losses, but we estimate that even the low end of the range of eventual losses on its $865-billion loan book is more than $50 billion. Wells must earn profits fast enough to fill the hole being blown in its loan portfolio before those losses overwhelm the company.
Can it do so? Our optimism that it can rests in no small part on the company's deserved reputation as a first-class operator.
Our confidence got a further boost when Wells announced exceptionally strong first-quarter earnings of $3 billion, driven by far lower charge-offs than we expected. Wells's net interest margin -- the amount by which interest income exceeds interest expenses, as a percentage of assets -- was 4.1% in the first quarter, significantly higher than the sub-3% margins reported in 2008 by Bank of America, Citigroup and JPMorgan Chase. Over the past five years, Wells has delivered annual earnings growth before taxes and loan-loss provisions of 11%, on average, while its nine largest peers have seen such earnings decline, on average.
With the addition of Wachovia and assuming some cost savings, we believe Wells should earn $32 billion to $40 billion this year before taxes and loan-loss provisions. Those adjusted earnings, we believe, will meaningfully exceed additional provisions for credit losses in 2009. If earnings at least keep pace with loan losses, as we expect, Wells should survive the storm.
If that happens and Wells doesn't have to raise additional capital -- we think there's only a 10% to 20% chance it will have to -- the $4 to $5 per share it should earn in a normal environment would translate into a stock worth $40 to $60. With the stock at $20 (as of April 9), we think the risk-reward equation is highly favorable.
One last point: Our optimism about Wells Fargo is not a suggestion that all is clear for bank stocks in general. Wells is uniquely profitable, which should allow it to earn its way out of trouble. But many other banks won't be so lucky and will be overwhelmed by their losses.
Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Funds co-managed by Tilson hold short positions in Bank of America, Washington Mutual and Citigroup.

-
-
A 10-Year Checklist For Retirement Planning
This checklist for retirement planning will help you get in shape 10 years out.
By David Rodeck Published
-
SIMPLE IRA: What It Is and How It Works
A SIMPLE IRA allows self-employed and small business owners to contribute funds toward their employees' and their own retirement savings.
By Seychelle Thomas Published
-
Stock Market Today: Stocks Swing Lower as Government Shutdown Nears
The main benchmarks erased some if not all of their early morning gains, putting the lid on a tough month and quarter.
By Karee Venema Published
-
Stock Market Today: Stocks Rise as Treasury Yields Retreat
A slow start turned into a fine finish for stocks as the bond market stabilized.
By Karee Venema Published
-
Stock Market Today: Stocks Waver as Government Shutdown Looms
Rising yields, higher oil prices and Washington's march toward its first shutdown since 2019 sapped risk appetite.
By Dan Burrows Published
-
Stock Market Today: Stocks Sink as Consumer Confidence Drops, Shutdown Looms
While today's selling was widespread, EV stocks Rivian and Fisker sizzled after receiving bullish analyst attention.
By Karee Venema Published
-
Stock Market Today: Mega-Cap Strength Keeps Stocks Above Water
The main benchmarks eked out increases Monday as several mega-cap stocks gained ground.
By Karee Venema Published
-
Stock Market Today: Stocks Lose Steam as Fed Hangover Lingers
Stocks attempted to bounce back from recent Fed-induced losses Friday, but struggled to stay higher through the close.
By Karee Venema Published
-
Stock Market Today: Stocks Head South as Treasury Yields Hit New Highs
Expectations for another potential rate hike sent yields on both the 2-year and 10-year Treasury bonds to their highest levels in almost two decades.
By Karee Venema Published
-
Stocks Close Lower After Hawkish Fed Pause
The major indexes finished in the red after the Federal Reserve kept interest rates unchanged, but left open the possibility of one more rate hike.
By Karee Venema Published