Investors Know Better Than to Short Wells Fargo Stock

By Markets Fool.com


One Wells Fargo Center in Charlotte, North Carolina. Image source: iStock/Thinkstock.

Continue Reading Below

Wells Fargo has made its fair share of mistakes over the years, but investors know better than to bet against its stock. The nation's third biggest bank by assets is the least shorted stock on the KBW Bank Index, which tracks 24 of the nation's leading lenders.

Only 0.42% of Wells Fargo's outstanding shares are currently sold short, according to data from YCharts.com. That compares to an average short interest ratio of 3.7% on the large-cap bank index. The next closest bank is JPMorgan Chase , which has a short interest of 0.63%.

10 Least Shorted Bank Stocks on the KBW Bank Index

Percent of Shares Sold Short

Wells Fargo

0.42%

JPMorgan Chase

0.63%

Bank of America

0.73%

First Niagara Financial

0.87%

US Bancorp

0.88%

Bank of New York Mellon

0.92%

Citigroup

0.92%

Northern Trust

1.03%

PNC Financial

1.11%

Capital One Financial

1.29%

Data source: YCharts.com.

On one hand, this is surprising. I say that because shares of Wells Fargo trade for a 47% premium to the bank's book value. That is much higher than the nearly 40% discounts that shares of Bank of America and Citigroup trade for. It's well above JPMorgan Chase's valuation as well. Shares of the nation's biggest bank by assets trade for an only 7% premium to book value.

Continue Reading Below

This suggests that Wells Fargo's shares have further to fall than those of its megabanking counterparts if the industry takes a turn for the worse. And, to be clear, this isn't an unreasonable thought, given the upcoming vote in the United Kingdom over whether to separate for the European Union, in addition to the fact that the Federal Reserve has intimated recently that it may soon clamp down further on big bank profits by requiring them to reduce leverage.

On the other hand, however, there's little doubt that Wells Fargo has earned its lofty valuation. Even though interest rates are near zero, which crimps bank profits by reducing the income from their loan and securities portfolios, it continues to earn a double-digit return on equity. Its ROE last year was 12.7%. That exceeds Wells Fargo's estimated 10.4% cost of equity capital and thus means that the California-based bank is creating value for its shareholders despite the challenging environment.

Wells Fargo also proved before, during, and after the financial crisis that it's one of the most prudently run banks in the country. It avoided the most toxic types of subprime mortgages in the lead-up to the crisis. It more than doubled in size during the downturn as a result of its bargain-basement acquisition of Wachovia. And Wells Fargo is one of the few big banks that have been permitted by regulators to ratchet up their dividends to the extent that it's paying out more per share today than it did eight years ago.

So, yes, Wells Fargo's shares may seem expensive compared to the likes of Bank of America, Citigroup, and even JPMorgan Chase. But there's little reason to think that they'll head demonstrably lower anytime soon. And given its industry-leading short interest ratio, you needn't just take my word for this.

The article Investors Know Better Than to Short Wells Fargo Stock originally appeared on Fool.com.

John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends Bank of America. 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.