Better Buy: Bank of America Corporation vs. Wells Fargo

By Markets Fool.com


Image source: Wells Fargo.

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The banking industry has rebounded sharply since the financial crisis, and big U.S. banks like Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC) have found ways to survive and thrive in the economic rebound that followed one of the toughest periods in American history. Yet many still view the U.S. recovery as being fragile, and uncertainty about potential future changes in interest rates could have a huge impact on B of A and Wells Fargo along with their peers.

Moreover, despite having paid billions in legal settlements, fines, and other dispute costs, recent events suggest that at least some banks still have structural issues they need to address in order to prevent future liability from hitting their profits. Many investors want to know whether Bank of America or Wells is the smarter pick right now.

Let's take a closer look at how Bank of America and Wells Fargo compare based on some popular measures of success, so you can decide which one is more appropriate for your investing needs.

Stock performance and valuation

Neither Bank of America nor Wells Fargo has given investors the sort of results they like to see recently. Since September 2015, B of A has produced flat returns, and that has actually outpaced Wells Fargo and its 8% drop over the most recent 12-month period.

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When you look at some simple valuation metrics based on earnings, the two stocks look quite similar. Using trailing earnings, Bank of America looks more expensive, sporting an earnings multiple of 13 compared to the lower 12 times earnings for Wells Fargo. Yet when you incorporate future earnings expectations into the mix, B of A looks like a better bet with its forward earnings multiple of 10; Wells Fargo trades at 11 times forward earnings, showing how close the two banks are to each other.

Yet where the two stocks truly differ is in the relationship of share prices to book values. Wells trades at a premium of about a third to its book value, reflecting the confidence that investors have in the assets on its books. By contrast, Bank of America trades at about a one-third discount to book value; that suggests more skepticism about B of A's asset base. Wells carries a strong reputation among investors, but Bank of America has more room to climb if things pan out well.

Dividends

Bank stocks used to be dividend giants, but the financial crisis forced nearly every bank to give its shareholders at least a temporary pay cut. Wells Fargo has largely recovered from tough times in the past, paying dividends that work out to a yield of more than 3%. Bank of America lags behind somewhat, with its 1.9% dividend yield suggesting that the bank hasn't been as successful in producing enough excess capital to return to shareholders.

In making quarterly dividend payments, Bank of America wasn't able to return to normal nearly as quickly as Wells Fargo. B of A paid token penny-per-share dividends all the way into mid-2014, only then sending the dividend to a nickel per share. The bank's most recent 50% increase makes each quarterly payment equal to $0.075 per share, but even that isn't enough to satisfy many investors.

Wells Fargo was faster to get back to normal, but it has been stingier with dividends as of late. Successive increases sent the dividend up sevenfold between 2011 and 2014. But over the past two years, the company has made less than a 10% total increase in dividends, including a mere half-penny per share this year.

With pluses and minuses for both stocks, a lot depends on your immediate needs. For current yield, Wells is the better bet, but B of A arguably has more growth in its future.

Growth prospects and risk

Until recently, most investors saw Wells Fargo as just about the perfect example of a strong bank, especially in comparison to the struggles that Bank of America had faced. Admittedly, the pressure from low interest rates has shown up in Wells Fargo's financial results, limiting its ability to maximize income from interest rate spreads. But Wells had been able to produce loan growth that kept its internal returns strong.

What has thrown a wrench into Wells Fargo's future is the allegation that the company's employees defrauded customers by opening roughly 2 million unauthorized accounts on their behalf, apparently in response to a corporate sales culture at Wells Fargo that put an unusual emphasis on cross-selling. The bank argues that these were unsolicited actions from employees, but enough workers were apparently involved that the scope of the problem seems to be larger than bank executives are suggesting. Wells Fargo agreed to pay fines of about $185 million, but the bigger question is whether customers will avoid the bank going forward.

For Bank of America, the potential for growth lies largely in finding ways to make up for some of its competitive disadvantages. For instance, Bank of America has a higher cost of capital than many of its peers, and as a result, the extent to which it has to tap capital markets for long-term debt financing eats into its net interest margins. Yet in its most recent earnings report, Bank of America did surprisingly well, successfully completing its multiyear effort to get rid of bad assets, and seeing the pace of legal losses fall dramatically. Going forward, B of A hopes to cut its internal costs and boost fee income while ensuring that it doesn't take on too much risk.

Both Bank of America and Wells Fargo have pros and cons, and the recent controversy over Wells Fargo has sent its share price somewhat lower. Some will see that as an opportunity to get Wells Fargo shares on the cheap, but others might argue that Bank of America has more upside potential and less downside risk.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short October 2016 $50 calls on Wells Fargo. The Motley Fool recommends Bank of America.

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