Banking and large-cap financial stocks can make for great long-term investments. In terms of risk, banking stocks fall in the middle of the spectrum, not too risky but not exactly risk-averse. There are certain inherent advantages of investing in banking stocks such as heavy regulation that ensures earnings stability, as well as high-profit investment banking services, and medium long-term risk.
However, the COVID-19 pandemic was not kind to the banking sector. Overall, the banking sector lost 1.7%% in market value in 2020. When compared to the overall gain of 18% of the S&P 500, it puts into perspective how much the banking sector underperformed.
Thanks to the overall market reopening’s and recovery, the banking sector is expected to return to pre-pandemic levels soon. Even though the performance of the banking companies, similar to the overall market, cannot be predicted with any degree of certainty, we can still make some educated guesses.
One of the most promising stocks in this sector currently, is Wells Fargo (NYSE: WFC). In this article, we’ll discuss four major reasons why Wells Fargo can make a good choice for long-term investment.
May Beat Inflation Long-Term
Banks make for great investments if the goal is to beat inflation, and Wells Fargo is particularly positioned to beat rising prices. The primary reason why banks do well against inflation is that they outperform during periods of higher prices, unlike most other sectors.
Wells Fargo is more focused on commercial banking and consumers when compared to the other large American banks. Hence, most of Wells Fargo’s revenues come from loan repayments and wealth management. In such a scenario, when the Federal Reserve increases its interest rate, Wells Fargo’s lending rate will also increase.
Since Wells Fargo’s revenue is more tied to interest rates compared to other banks, their revenues will rise by a higher percentage during times of high inflation when compared to peers.
Has High Reserves to be Released into Earnings
During the pandemic, every major bank started building up its reserves in an effort to combat future uncertainty. These reserves were meant to be an insurance against high incidences of loan losses that would happen in a faltering economy.
However, the worst did not come to pass. The American economy is showing strong signs of recovery from the effects of the coronavirus pandemic.
Most banks are now releasing their reserves back into their quarterly earnings. The difference is that Wells Fargo is doing the same but at a much slower rate. Hence, it still has plenty of reserves to be released into future earnings which will support bottom-line growth. This may act as a support for stock prices over the long term.
On Track To Remove Asset Cap
In 2018, Wells Fargo was hit with a scandal. The company had been opening credit card and depository accounts for its customers without their authorization. In retaliation, federal regulators slapped an asset cap of $1.95 trillion on the bank. This meant that the bank could not grow at a rate akin to its peers.
Now, fast-forward to 2021, the bank is on track to have this cap removed. The bank has overhauled its leadership team and is doing everything it can to make good with the regulators and have the asset-cap removed.
High Potential Value Play
Wells Fargo is currently a value stock, trading at just approximately 130% of its tangible book value. The primary reason behind Wells Fargo’s low valuation is the regulatory asset cap that was slapped on the bank after the 2018 unauthorized accounts scandal.
What Wells Fargo needs is a good turnaround story, which it seems to have. The company has been working on overhauling its cost and expense structure which could mean significantly higher profitability, apart from a new leadership team as mentioned earlier.
Over the long term, Wells Fargo can make a good value play as the bank recovers from its erring ways.
In short, currently, Wells Fargo makes for a good potential long-term investment. The bank has many things going for it, which is indicated by the approximately 50% rise in share prices in the first half of 2021.
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