Profiting from the Wells Fargo Turnaround Story
Last week, Wells Fargo (NYSE: WFC) closed below $44 for the first time since last December’s market correction. By now, you know the story. Over the past three years, the bank has been racked by damaging revelations regarding its internal sales practices and subsequent attempts to cover them up.
I used to own WFC in the Personal Finance growth portfolio. Fortunately, I unloaded it two years ago while it was trading near $55. Ever since, I have watched from the sidelines while its share price steadily declined.
However, I now believe Wells Fargo is close to bottoming out. Its former CEO, Tim Sloan, resigned last March. Sloan was in charge while the bank engaged in its deceptive sales activities. Yet, he tried to stay on to salvage the situation even though his inevitable departure was only a matter of time.
Over the past five months, the bank has quietly engaged in a search for the right person to reclaim its former glory. That process has been influenced by the looming presence of Warren Buffett, the legendary chairman of Berkshire Hathaway (NYSE: BRK.A, BRK.B).
Berkshire owns nearly $20 billion of WFC stock, making it the company’s single largest shareholder. That also makes WFC Berkshire Hathaway’s fourth-largest holding, comprising almost 10% of its stock portfolio.
Buffett doesn’t like to admit defeat. In the case of Wells Fargo, he chose to stay and fight rather than throw in the towel. With Buffett still on board, Wells Fargo should be able to hire a first-class CEO.
Also hurting Wells Fargo (and most other banks) is the recent decline in interest rates. Banks rely on net interest income, the difference between the rates they pay on savings versus the rates they charge on loans, as their primary source of cash flow.
When rates are as low as they are now, there simply isn’t enough space between loan and saving rates to produce a meaningful profit. For that reason, banks have diversified into fee-based businesses such as wealth management to offset that lost spread income.
In that regard, Wells Fargo is among the industry leaders with 42% of its total revenue coming from non-interest income. As a result, the company has been able to generate more than $21 billion in earnings in each of the past six years despite its public relations fiasco.
At the same time, Wells Fargo has been paring back its menu of services to improve its operating metrics. Over the past two years, the company has sold its Insurance Services, Shareowner Services, and Institutional Retirement & Trust divisions.
The proceeds from those sales have been reinvested in the growth of Wells Fargo retail and commercial banking operations. The bank boasts more than 70 million customers and claims to be #1 in retail deposits in the U.S.
In short, Wells Fargo appears to have survived its highly publicized scandal without losing its core business. The low-margin business lost to state and federal agencies as punishment for its misdeeds has been offset by higher-margin retail and commercial lending and deposit activity.
That being the case, why is Wells Fargo now trading at its lowest share price since 2013? Some of that can be attributed to fallout from its botched attempts to repair its public image. But the simple fact of the matter is bank stocks are cheap due to historically low interest rates and fears of a recession.
Since August 1, the SPDR S&P Bank ETF (NYSE: KBE) has fallen 10% due to escalating trade tensions with China and negative interest rates in Europe. All the major banks have taken a similarly sized hit this month including Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), and Citigroup (NYSE: C).
Of course, if the U.S. goes into recession, all of the major banks are likely to suffer. But if it does not, most of them should recover strongly. And leading the charge could be a reinvigorated Wells Fargo under the direction of a new CEO.
The most direct way to participate in such a scenario is to simply buy shares of Wells Fargo. At a recent price of $45, WFC sports a forward annual dividend yield of 4.6%. That’s more than triple the 1.5% yield on the 10-year Treasury note.
But there is a better way to earn a higher cash yield off of WFC with the possibility of buying it at even lower share price. Sell a “naked put” on it that expires on December 20 with a strike price of $42.50.
A few days ago while WFC was trading at $45, that put could be sold for a premium of $1.60. That’s your money to keep no matter what happens.
On an annualized basis, that works out to a options premium yield of 11.3%.
That premium is to compensate you for assuming the risk that WFC may drop below $42.50 over the next four months. If it does, you’ll have to buy it at that price (and begin collecting its big dividend yield).
This is the type of win-win scenario that professional investors look for. And it is the type of trade that my colleague, Amber Hestla, made successfully 49 times during the past year to generate consistently high income.
Amber Hestla is chief investment strategist of the premium trading service, Income Trader. She’s a financial expert but she’s also a military veteran. Amber served with distinction in Operation Iraqi Freedom. While deployed overseas with military intelligence, she learned how to interpret disparate data to predict likely outcomes. Upon her return to civilian life, Amber honed this skill to find money-making opportunities.
Want to learn Amber’s money-making secrets? Click here for a presentation.