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The biggest U.S. banks have reported impressive numbers this earnings season.
There’s buzz about their stocks because rising interest rates are improving profits and there’s no sign of a sector-killing recession.
But Wells Fargo takes the prize if you are looking among the largest U.S. banks for a long-term play on the good times for the financial sector. The San Francisco-based bank’s shares have slumped 16% this year after regulators levied fines and constrained expansion plans. Still, the bank has tended to be a strong, consistent performer, and its stock has an attractive dividend yield. It’s Warren Buffett’s favorite bank stock.
Investor and newsletter writer Nigam Arora shared six reasons for investors to consider buying bank stocks. If you’re looking to invest in individual banks and wondering which ones to consider, a combination of consistently high returns on common equity and a relatively low stock valuation may help point the way.
The S&P 500 banking sector trades for 12 times weighted aggregate consensus earnings estimates for 2018 among analysts polled by FactSet. That compares to a price-to-earnings ratio of 17 for the entire S&P 500 So the banks trade for 71% of the P/E valuation for the index, which is a typical discount for the group. Five of the big six U.S. banks trade for less than 12 times 2018 EPS estimates.
The big six
Here are the six largest U.S. banks by total assets, sorted by return on common equity (ROCE) during the first quarter. A bank’s return on common equity is its annualized net income divided by the amount common shareholders have invested in the company.
You can also see a comparison of the first-quarter ROCE with those of a year earlier, as well year-to-date stock performance, P/E ratios and dividend yields:
| Company | Ticker | ROCE - first quarter 2018 | ROCE - first quarter 2017 | Median ROCE - past four quarters | Total return - 2018 through April 18 | Price/ consensus 2018 EPS estimate | Dividend yield - current |
| J.P. Morgan Chase & Co. | 15.0% | 11.1% | 11.7% | 4% | 12.3 | 2.03% | |
| Morgan Stanley | 14.9% | 11.1% | 10.1% | 2% | 11.8 | 1.88% | |
| Goldman Sachs Group Inc. | 13.5% | 11.9% | 10.5% | 0% | 11.2 | 1.26% | |
| Wells Fargo & Co. | 13.2% | 12.4% | 13.1% | -16% | 10.9 | 3.08% | |
| Bank of America Corp. | 11.5% | 8.0% | 8.8% | 2% | 11.8 | 1.60% | |
| Citigroup Inc. | 10.0% | 7.7% | 7.5% | -6% | 10.8 | 1.84% | |
| Source: FactSet | |||||||
So Wells Fargo trailed J.P. Morgan Chase Morgan Stanley and Goldman Sachs for first-quarter ROCE, when the investment banks enjoyed higher trading revenue during an increase in market volatility. Wells Fargo has also been, by far, this year’s worst stock performer, as the company’s scandals have taken their toll.
But if you look at the figures for the past five full years, a different story emerges:
| Company | Ticker | Average annual ROCE - 5 years | ROCE - 2017 | ROCE - 2016 | ROCE - 2015 | ROCE - 2014 | ROCE - 2013 |
| Wells Fargo & Co. | 12.8% | 11.5% | 11.8% | 12.8% | 13.7% | 14.0% | |
| J.P. Morgan Chase & Co. | 9.7% | 9.9% | 10.0% | 10.3% | 9.8% | 8.4% | |
| Goldman Sachs Group Inc. | 8.8% | 5.0% | 9.4% | 7.5% | 11.2% | 11.0% | |
| Morgan Stanley | 6.8% | 8.2% | 8.1% | 8.6% | 5.0% | 4.4% | |
| Bank of America Corp. | 5.3% | 6.8% | 6.8% | 6.3% | 1.7% | 4.6% | |
| Citigroup Inc. | 4.1% | -4.1% | 6.7% | 8.0% | 3.4% | 6.7% | |
| Source: FactSet | |||||||
Wells Fargo has been the strongest performer of the group during each of the past five full years. But it has the second-lowest P/E valuation — trading only slightly higher on a P/E basis than which has been the worst ROCE performer among the big six.
Wells Fargo is still under regulators’ lens. Regulators have restricted the bank’s growth and ousted some board members. The company said in February that penalties by the Federal Reserve could cost $400 million.
But the restriction on growing its assets will mean even more excess capital for Wells Fargo, which can feed more stock buybacks and higher dividend payouts. This is a rare opportunity for investors. Wells Fargo is on sale, and a few years from now you may look back and celebrate the opportunity or regret that you missed it.