Since my last article on Wells Fargo (NYSE:WFC) in mid-December, it has dropped 12.5%. I argued that WFC stock was overvalued and that it had likely peaked. Now I am starting to look more carefully at Wells Fargo. Maybe it is time to start buying again.
At the time, I compared WFC stock to its peers both in terms of its loan growth and its valuation. In both cases, WFC came up short.
In mid-December, Wells Fargo had a dividend yield of 3.8%. But now it is 4.3%. This is still higher than its peers. However, I pointed out in my prior article that Wells Fargo pays out a larger portion of earnings in dividends.
Buffett Reduces Stake in Wells Fargo
I also suspected that Warren Buffett, CEO of Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B), had reduced his company’s stake in Wells Fargo. At the time, Berkshire held 378.4 million shares of WFC stock or an estimated 9% stake. This was a drop from the 9.9% stake held last March.
But now, as of Feb. 14, Buffett filed a U.S. Securities and Exchange Commission 13G report showing that the combined stake had fallen even further. As of that date, the combined stake had fallen to 345.7 million shares or 8.4% of WFC stock.
As a result, Buffett has continued selling into Well Fargo’s large share repurchases over the past year.
Wells Fargo has not yet reported its earnings and loan growth for 2019. So, we don’t know yet how it performed in Q4. It is also not clear yet how it has performed against its peers.
But one thing is clear. Wells Fargo is likely to increase its dividend and buybacks, based on its past history.
Expect Another Dividend Hike
Wells Fargo seems to increase its dividend, as most banks do, once a year. Each bank must submit its dividend plans to the Federal Reserve for approval. They also must typically report buyback programs.
I believe that WFC stock will start to benefit from speculation that a dividend hike will occur by mid-July. So far this year, Wells Fargo has declared three dividends at 51 cents per quarter, or $2.04 annualized.
Last year it raised the dividend twice. It paid out 43 cents for two quarters and then raised its dividend to 45 cents for the last two quarters. Then in July 2019, it hiked the dividend 11.7% again to 51 cents. Now it has paid that dividend for three quarters in a row.
If the dividend were to be raised by 10% or 11% to 56 or 57 cents per share, the annualized dividend would be very attractive. A 10% hike would put the annualized dividend payment at $2.24 per share.
At today’s price that would give WFC stock a dividend yield of 4.7%. An 11% increase would put the dividend rate at $2.28 per share, an annual yield of 4.8%.
I believe that would make WFC stock very attractive. The stock will start to rise in anticipation of the dividend hike.
What Is WFC Stock Worth?
According to Seeking Alpha, during 2019 WFC had an average dividend yield of 3.7%. And during 2018 the average yield was 2.9%. So the average yield over the past two years was 3.3%.
Now if we assume that the new annualized dividend rate will be $2.28 per share, we can use the average yield to estimate where WFC stock might trade. We do this by dividing $2.28 by 3.3%.
The answer is $$69.09 per share, or 48% higher than today. Even if we use the lower estimated dividend rate of $2.24 per share and also use the 2019 average yield of 3.7%, the target price is $60.54 per share. That would still be 30% higher than today’s price.
Therefore, we can estimate that WFC stock is anywhere from 30% to 48% undervalued if the company decides to hike its dividend. This also assumes the dividend hike will be similar to its earlier increases.
Will WFC Raise Its Dividend?
A lot of that depends on how well its 2020 earnings are expected to turn out. Analysts will begin to price in another dividend hike if its Q1 and Q2 earnings and loan growth start to stabilize.
The problem is that earnings have been positive but falling on a year-over-year basis for the past four quarters, including Q4 2019. The same is true about revenue. Wells Fargo has to get its act together. That is probably why Buffett has been selling.
It could be a question of whether the dividends will be raised. I believe that the company will do this. One reason is that the large dollar amount of buybacks allow Wells Fargo to not have to spend as much on the dividend even if it is raised.
Another reason is that investors expect a dividend increase. So if WFC doesn’t increase the dividend, it could hurt the stock price.
Finally, Wells Fargo can afford a higher dividend. Analysts are expecting $4.08 in earnings for 2020, according to Seeking Alpha. So even if the dividend is raised to $2.24 per share, that represents only a 55% payout ratio.
WFC stock is cheap at today’s price, but it will be even more cheap if the dividend rises in July. It is likely the company will do this despite the fact that earnings growth has been negative over the past four quarters. At some point in the next quarter the stock will likely rise based on the expected dividend hike.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers get a two-week free trial.