The Secret Advantage of Wells Fargo Stock

Aside from the fact that Wells Fargo knows a thing or two about highly profitable banking, there's another reason that shareholders in the nation's fourth biggest bank by assets can thank themselves for owning its stock: It buys back more shares than any other U.S. lender.

Since the second quarter of 2013, Wells Fargo has spent $14.5 billion repurchasing its common stock. Runner-up JPMorgan Chasebought back $10.1 billion worth over the same stretch. Bank of Americaand Citigroupweigh in at $5.7 billion and $3.9 billion, respectively.

To be fair, one could argue that Wells Fargo doesn't have much say in the matter. Because it earns so much money -- its return on equity last year was 11.7%, second only to US Bancorp among the nation's largest lenders -- it's effectively forced to do something with it.

A bank can't retain all of its earnings because that increases its shareholders' equity relative to its net income. This weighs on its return on equity and thereby tarnishes the appeal of its stock.

Banks with more than $50 billion in assets on their balance sheets also can't distribute all of their earnings by way of dividends. This follows from the fact that a bank's earnings go up and down with the credit and interest rate cycles. Any drop would thereby trigger a dividend reduction, which, in turn, can erode investors' confidence in a bank and make it difficult to raise inexpensive capital if the need arises.

Furthermore, the Federal Reserve has been clear over the past few years that it generally favors stock buybacks over high dividend payout ratios in its annual Comprehensive Capital Analysis and Review process, which gives the central bank veto power over big banks' capital plans. While lenders can stop or start a repurchase plan at will, the Fed assumes that the pressure to avoid cutting one's dividend could jeopardize a bank's capital cushion when the economy takes a turn for the worse.

By process of elimination, this leaves buybacks as the preferred method among most banks to return capital to shareholders in excess of the roughly two-thirds of net income that's ideally divided evenly between retained earnings and dividends.

It's for this reason that Wells Fargo's stock offers shareholders the secret advantage of massive buybacks, as no publicly traded U.S. financial company earns more excess net income on a regular basis than the California-based mortgage giant.

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John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of 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.

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