The Best Bank Stock to Buy in October

By Markets

Wells Fargo's office in Charlotte, North Carolina. Image source: iStock/Thinkstock.

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If you want to be good at investing, then you have to buy stocks when they're cheap. This isn't controversial in theory, but it does raise eyebrows when it's put into practice.

To this end, I believe that the best bank stock to buy in October is Wells Fargo (NYSE: WFC).

When Buffett buys bank stocks

How could I say this after the California-based bank was caught defrauding millions of its customers for the purpose, at least in part, of enriching its executives?

I say it because the scandal caused Wells Fargo's stock to lose 13% of its value last month. It trades right now for 1.3 times its book value, a low valuation for a bank that has long led the industry in terms of efficiency and profitability.

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Times like this remind me of when Warren Buffett bought Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) 10% stake in Wells Fargo in 1989 and 1990.

Analysts and commentators at the time thought the bank was on the brink of failure. And they believed this for good reason.

Thousands of banks and savings and loans had gone under during the previous decade, in which the industry was wracked by multiple crises. The savings and loan crisis is the best known today, but there was also the less developed country crisis, in which governments throughout Central and South America began defaulting on loans issued by U.S. banks.

To make matters worse, the beginning of the 1990s introduced yet another crisis, this time in the commercial real estate market, which has long been a mainstay of Wells Fargo's operations.

Here's Buffett talking about this in his 1990 letter to Berkshire Hathaway's investors:

Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled -- often on the heels of managerial assurances that all was well -- investors understandably concluded that no bank's numbers were to be trusted. Aided by their 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.

Buffett has applied this same approach time and again throughout the years:

  • He invested in American Express in the 1960s, after a scandal caused its stock to plummet.
  • He injected $5 billion of Berkshire Hathaway's money into Goldman Sachs at the nadir of the latest financial crisis.
  • And he did the same with Bank of America three years later, in 2011, when it looked as if the nation's second biggest bank by assets was on the verge of going kaput.

And how has it paid off for Buffett and Berkshire Hathaway's shareholders? Pretty darn well. His 10% stake in Wells Fargo, which cost $290 million, is worth around $22 billion today.

An appropriate approach

There is, of course, no guarantee that Wells Fargo stock won't continue to fall over the weeks and months ahead. That, in fact, is what I assume will happen, as it faces a litany of legal and regulatory challenges that it must contend with before putting its fake account scandal to rest.

As it gets cheaper, however, it gets more, not less, attractive. You can already see this in the case of Wells Fargo's dividend yield. Before its troubles were revealed last month, shares of the bank yielded less than 3%. Today, they yield nearly 3.5%.

That's a hefty dividend when you consider that the average stock on the S&P 500, which is made up of the biggest and best companies in America, yields only 2.1%.

That said, given the likelihood that Wells Fargo's stock could continue to drop from here, enterprising investors should factor that into the timing of any potential purchase.

I don't mean that you should try and call the bottom, so to speak, as we know that isn't possible absent luck. But what I do mean is that you should average into a position. Buy some this week, some next week, and some the week after that, for instance.

This strategy increases the odds that you can have your cake (Wells Fargo's shares at a seemingly low valuation) and eat it too (not miss out on the chance that its shares will fall further).

In sum, while there's no excuse for the massive, years-long scandal that occurred at Wells Fargo over the past decade, these are the opportunities that investors should run toward, not away from.

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John Maxfield owns shares of Bank of America, Goldman Sachs, and Wells Fargo. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Wells Fargo. The Motley Fool has the following options: short October 2016 $50 calls on Wells Fargo. The Motley Fool recommends American Express and 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.