Wells Fargo & Company (Wells Fargo) is a US-based bank that provides diversified financial services to its clients and has assets exceeding $19 trillion (Wells Fargo, 2019a). The bank was established in 1852, and its head office is located in San Francisco, California. The bank has an extensive network of 7,600 branches and 13,000 ATMs (Wells Fargo, 2019a). It has international offices in 32 countries and has a workforce of 263,000 individuals (Wells Fargo, 2019a). Wells Fargo is listed at number 29 on Fortune’s 2019 list of the largest US companies. This report analyzes its financial position and compares it with previous years. Moreover, it includes projections of the bank’s income statement and balance sheet for the next five years based on the expected growth rates. Furthermore, it determines the Required Rate of Return (RRR) by shareholders, the Weighted Average Cost of Capital (WACC), and the Intrinsic Value (IV) of the bank’s stocks five years from now.
The financial performance of Wells Fargo is evaluated over the last three years by using ratio analysis.
Table 1. Financial Ratio Analysis
Table 1 provides values of key financial ratios for assessing the financial performance of Wells Fargo in the last two years. The Net Interest Margin (NIM), which is the difference between the bank’s interest income and interest expense slightly increased in 2018. The Loan to Assets Ratio value increased in 2018, which means that the bank approved more commercial and consumer loans that also generated a higher net interest income as compared to 2017. The Return on Assets (ROA) improved by 3.62%, but its values indicate that the bank’s profitability remained weak in the last two years. The Earnings Per Share (EPS) of Wells Fargo increased by 4.11% from 4.14 to 4.31, which also convinced the management to increase the quarterly dividend payout to the bank’s shareholders from $0.43 in the last quarter of 2018 to $0.45 in the first quarter of 2019. The Credit to Deposit Ratio was 0.73 and 0.71 in 2018 and 2017, respectively, which showed that the bank efficiently used its deposits to give loans to its customers (Gupta & Gupta, 2018). The bank improved its loan management efficiency as the ratio of non-performing assets to total assets reduced from 0.88% in 2017 to 0.74% in 2018. The loss incurred by Wells Fargo due to non-performing loans also declined in 2018.
The Required Rate of Return (RRR) is calculated in the following based on the dividend discount model. The current stock price of Wells Fargo is $53.80 (Yahoo! Finance, 2019a), and it paid a dividend of $1.92 per share in 2019 (Wells Fargo, 2019b). Moreover, the current P/E ratio of Wells Fargo is 12.57 (53.80 / 4.28), which implies that its stocks are presently trading at a higher multiple of its earnings per share and shareholders hold a positive view about it and their investments in the company. The forward dividend expected will be $2.04 (Yahoo! Finance, 2019a), which indicates a growth rate of 6.25% ((2.04 / 1.92) – 1) in the next period.
RRR = (Forward Dividend / Current Share Price) + Dividend Growth Rate (Brigham & Houston, 2016)
RRR = (2.04 / 53.80) + 6.25% = 10.04%
The shareholders of the company expect a return of 10.04% on their equity investment in its stocks. Another approach to calculate RRR is to use the Capital Asset Pricing Model (CAPM) which includes systematic risk associated with the investment in the company’s stocks and is calculated in the following:
Risk-free Rate = 1.68% (“Implied market-risk-premia: USA,” 2019)
Market Risk Premium = 4.30% (“Implied market-risk-premia: USA,” 2019)
Stock Beta = β = 1.24 (Yahoo! Finance, 2019a)
Re = Rf + B * (Rm – Rf) (Brigham & Ehrhardt, 2016)
Re = 1.68% + 1.24 * 4.30% = 7.01%
The RRR is 10.04% which is the cost of equity contributed by shareholders. It is used for calculating the Weighted Average Cost of Capital (WACC) of Wells Fargo. It is noted that the company paid interest of $14.652 billion on its long-term debt of $229.044 billion (Yahoo! Finance, 2019b). The cost of debt is calculated below:
Rd = Interest Expense / Total Debt
Rd = 14.652 / 229.044 = 6.40%
The effective tax rate of Wells Fargo was 18.90% in the last reported period, which is used in the calculation of the WACC in Table 2.
Table 2. Wells Fargo Debt and Equity Proportions
WACC = Proportion of Debt * Rd * (1 – Effective Tax Rate) + Proportion of Equity * Re
WACC = 50.50% * 6.40% * (1 – 19.84%) + 49.50% * 10.04%
WACC = 7.56%
The income statement and balance sheet of Wells Fargo for the next five years are projected based on the following assumptions and are attached in the appendix.
- The proportion of interest income, non-interest income, interest expense, and non-interest expense to total income is calculated through a vertical analysis (common size) of the income statement for the period ended on December 31, 2018.
- The proportion of all components of assets, liabilities, and equity to total assets is calculated through a vertical analysis (common size) of the balance sheet as of December 31, 2018.
- The total income of Wells Fargo is expected to grow at a slow pace over the next five years due to the low-interest rates in the US and the requirement of adopting new accounting standards (PYMNTS, 2019). The company achieved a growth rate of 3.40% in 2018. The expected growth rate will decline in the next three years and rebound in the fourth year. The projected growth rates are 3%, 2.5%, 2.25%, 2.5%, 2.75%, and 3% over the next five years.
- The bank’s assets are forecasted to increase in line with the projected total income over the next five years but at a slightly lower rate. The common stock value will not change. The liabilities of the bank will increase by CAGR of 13.69%. It implies that the increase in the firm’s assets will be mainly funded by liabilities in the form of new deposits.
The comparison of the bank’s financial performance between 2018 and 2023F is carried out in Table 3.
Table 3. Financial Ratios
The NIM and Loan to Assets Ratio of Wells Fargo are expected to increase over the next five years. The ROA is also projected to increase from 1.09% to 1.21%, which implies that the bank’s EPS will significantly grow. The bank’s policy is to maintain strong liquidity that will ensure that the Credit to Deposit Ratio will not change over the next five years.
The stock price of Wells Fargo after five years is projected by using the multi-stage dividend discount model. The growth rate is assumed to be 6.25% from Year 1 to Year 5. The terminal value is calculated in Table 4 by using the following formula:
Terminal Value = D5 / (WACC – g)
Table 4. Intrinsic Value of Wells Fargo
The projected stock price of Wells Fargo is $40.21 based on the five-year model implemented. The intrinsic value is less than the current stock price of the bank, which implies that the bank’s stocks are overpriced. The shareholders can expect to incur a loss on their holdings of Wells Faro’s stocks. The market could experience a downward shift in the stock price in the future. The arithmetic mean of the dividend growth rate over the last five years was 6.98% which generates an intrinsic value of $41.26. It also indicates that the bank’s stocks are overvalued, and there could be a significant correction in their value. Therefore, it is recommended that investors should sell the bank’s stocks to avoid losses.
References
Brigham, E. F., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.). Boston, MA: Cengage Learning.
Brigham, E. F., & Ehrhardt, M. C. (2016). Financial management: Theory & practice (15th ed.). Mason, OH: Cengage Learning.
Gupta, R. K., & Gupta, H. (2018). Credit appraisal & analysis of financial statements: A hand book for bankers and finance managers (2nd ed.). Chennai, India: Notion Press.
Implied market-risk-premia: USA. (2019). Web.
PYMNTS. (2019). US bank dials back growth forecasts. Web.
Wells Fargo & Company. (2019). Wells Fargo & Company | 2018 annual report. Web.
Wells Fargo. (2019a). Wells Fargo today. Web.
Wells Fargo. (2019b). Stock price and dividends. Web.
Yahoo! Finance. (2019a). Wells Fargo & Company (WFC). Web.
Yahoo! Finance. (2019b). Wells Fargo & Company (WFC) – Financials. Web.