Here's Why Wells Fargo Is a "Widows and Orphans" Stock

By Markets Fool.com


Wells Fargo Tower in downtown Portland, Oregon. Image source: Barry Caruth via Flickr.

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A look at Wells Fargo's historical profitability reveals why it's long been considered a "widows and orphans" stock -- i.e., one that's appropriate for even the most conservative of investment scenarios.

One of the great things about Wells Fargo is that it doesn't hide from its past. It makes available on its website every annual report that it's issued since 1967. Its competitors, meanwhile, offer previous annual reports dating back to 1998 at best, and more commonly for only the past decade or so.

Unlike other banks, there is no incentive for Wells Fargo to hide its historical performance. If anything, the California-based bank has every reason to feature it prominently. As you can see in the chart below, which contains profitability data gleaned from these reports, Wells Fargo hasn't lost money on an annual basis for at least half a century.


Data source: Wells Fargo annual reports: 1967-2015.

It's true that Wells Fargo has experienced troubles along the way. In 1987, for example, its return on equity dropped from over 11% the year before down to less than 3%. To a large extent, however, that drop was voluntary, stemming from Wells Fargo's notoriously conservative approach to loan loss provisions.

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Thanks to souring loans made to governments throughout Latin America, Wells Fargo nearly tripled its provisions in 1987. Because these are the functional equivalent of an expense on the income statement, the decision to set aside so much money in anticipation of future loan losses decreased Wells Fargo's net income that year by more than 90% compared to 1986.

Most importantly, by setting aside so much in 1987, Wells Fargo positioned itself to earn record profits the two following years, as it could be less aggressive insofar as provisioning was concerned. In 1989, for example, it recorded a smaller provision than it did in 1985 despite nearly doubling in size in the intervening years.

This sequence of events explains why the two most notable dips in Wells Fargo's profitability -- in 1987 and 1991 -- were followed immediately by meaningfully higher profits. It also explains why Warren Buffett was so eager to buy shares of Wells Fargo in 1990 after investors dumped its stock out of fear of a commercial real estate crisis in its home state of California.

"Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks," Buffett wrote in his shareholder letter that year. "Aided by [investors'] flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings."

It would be an understatement to say that Buffett's bet on Wells Fargo has paid off. The holding is currently valued at $23 billion and generates dividend income of roughly $720 million a year.

Why has Well Fargo done so well? Not only has it avoided recording an annual loss for the past 50 years, which is a notable accomplishment given the multitude of financial and banking crises over this stretch, but it's also consistently generated a respectable 12.8% average return on equity since 1966. It's these two reasons, in turn, that make Wells Fargo one of the safest and most lucrative bank stocks to own even today.

The article Here's Why Wells Fargo Is a "Widows and Orphans" Stock originally appeared on Fool.com.

John Maxfield owns shares of Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short May 2016 $52 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.