The nation's third-biggest bank by assets lets investors have their cake and eat it, too. Image source: iStock/Thinkstock.
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Wells Fargo (NYSE: WFC) is a great stock for many reasons, but there's one in particular that makes it an especially enticing investment right now. Namely, it yields more than the average stock at the same time that it offers meaningful upside potential. This gives investors the chance to have their cake and eat it, too.
Traditional trade-off: income or growth
A stock's yield shows how big its dividend is compared to its share price. If a stock pays $2 in dividends every year and its shares cost $100 each, then its yield is 2%. If it pays $3, it yields 3%. And so on.
There's no magic number when it comes to yield. Some stocks yield 10% or more (real estate investment trusts, or REITs, come to mind). To qualify for an exemption from corporate income taxes, REITs pay out at least 90% of their taxable income every year to shareholders. This is why the yield is so high; it compensates investors for forgoing organic growth.
On the other end of the spectrum are young companies that retain all of their earnings to fund growth. Technology companies often fall into this category. Even ones as established and profitable as Google's parent company, Alphabet, and Facebook have yet to begin paying out cash to shareholders. The net result is that these companies aren't viable investments for income-seeking investors.
Wells Fargo offers income and growth
The great thing about Wells Fargo's stock is that you don't have to pick between these alternatives, both of which require a choice between income and growth. True, it doesn't yield as much as a REIT does. But Wells Fargo's 3.1% yield ain't too shabby when you consider that the typical stock on the S&P 500 yields 2.1%.
On top of this, while no one could say with a straight face that Wells Fargo's stock is cheap, its valuation is almost certainly bound to go higher in the years ahead. I say that because it's operating in an incredibly challenging environment right now, with low interest rates costing it tens of billions of dollars' worth of interest income each year.
We don't know when interest rates will rise, of course, but it's fair to say that they will, as they've essentially got no other direction to go in. Maybe it'll happen this year, maybe not. Maybe next year. We just don't know.
But what we do know is that interest rates will eventually go up, and we also know that banks will make a lot more money when they do, which would presumably have a positive impact on valuations across the industry. In Wells Fargo's case, it isn't unreasonable to think that it could trade for 2.0 or more times its book value, compared to its current multiple of 1.4.
Thus, while Wells Fargo offers neither an extremely high dividend nor massive growth potential, it has just enough of both to make it an attractive stock to own right now.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Maxfield owns shares of Facebook and Wells Fargo. The Motley Fool owns shares of and recommends Alphabet (A shares), Facebook, and 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.