When it comes to investing, some people prefer to choose from among the leaders of an industry. In banking, Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC) are among the biggest financial institutions in the world, and despite facing very different challenges, they've come a long way since teetering on the precipice of ruin during the financial crisis.
Now, things are looking up for financials, with favorable interest rate movements and a friendlier regulatory environment in Washington helping to boost their prospects. With that in mind, investors want to take maximum advantage of improving conditions, and so they want to know whether Bank of America or Wells Fargo are good buys right now, and if so, which one's the smarter choice. The following short analysis gives some insight into the question.
Image source: Bank of America.
Stock performance and valuation
When you look at recent share-price gains, it's easy to pick a winner between these two banking behemoths. Bank of America has seen its stock jump 36% over the past 12 months, while Wells Fargo is higher by just 8% since June 2017.
At first glance, it appears that you'd have to pay up for B of A at these levels. With basic valuation measures based on past earnings, Bank of America trades at 17 times what it's earned over the past 12 months, compared to a trailing multiple of just 13 for Wells Fargo. However, some of those recent numbers have gotten skewed by one-time impacts like tax reform. When you incorporate near-term future projections for profits, both B of A and Wells sport forward earnings multiples of between 10 and 11, making them look fairly similar.
Bank of America even looks cheaper than Wells on some metrics. For example, price-to-book ratios are an important measure of value for banking institutions, and there, B of A comes in at less than 1.3 times book compared to a 1.5 ratio for Wells Fargo. Given its more favorable momentum, Bank of America looks like the smarter choice on this measure.
Most banks have seen their dividends return to some extent following a period of minuscule payouts in the immediate aftermath of the financial crisis. Yet some banks have been better about sharing their rediscovered wealth with shareholders than others. Wells Fargo pays a dividend yield of about 2.9%, which is well above the 1.6% yield that Bank of America pays.
That disparity has been in place for some time. Wells Fargo made it a priority to restore its dividends to their full pre-crisis level quickly, and it achieved that goal fully four years ago. Since then, Wells has delivered even more payout boosts to its shareholders. B of A, however, only started raising its dividend four years ago. Increases have been considerable, but the company's 25% payout ratio is a lot stingier than the roughly 40% of earnings that Wells pays right now. Bank of America will have to work hard to get its dividend back above the market average around 2% and catch up to some of its more generous competitors.
Growth prospects and risk
Although banks share a lot in common, different companies have different exposures to the industry. For Bank of America, a rising interest rate environment has already had dramatic impacts on its bottom line and could continue to deliver outsized performance. With a greater proportion of customer deposits in non-interest-bearing accounts, B of A benefits more from interest rate hikes than those banks that have to pay interest to keep customers happy. Even a single percentage-point increase in rates adds billions to Bank of America's interest income with almost no associated rise in expenses for those accounts. In addition, B of A has made smart corporate moves, including branch closures and technological adoption, that have cut internal costs, and the resulting savings has made the bank more efficient. Despite long-held concerns about how it lagged coming out of the financial crisis, Bank of America appears to have hit its stride and is poised to regain its leadership role in the industry.
By contrast, Wells Fargo is having more struggles than ever. The bank hasn't recovered from the reputational damage that came from its employees opening bogus accounts for millions of customers two years ago, and since then, additional allegations have resulted in further hits. In April, the bank agreed to pay a $1 billion fine to the Consumer Financial Protection Bureau in connection with allegations that Wells wrongfully forced auto loan borrowers to pay insurance-related fees and also overcharged mortgage borrowers on rate-lock fees. With hundreds of thousands of customers affected, it could be increasingly difficult for Wells to grow even assuming the limits on expansion imposed recently by the Federal Reserve get lifted.
Stick with Bank of America
Overall, it's hard to justify choosing Wells Fargo over Bank of America right now. Despite having a higher dividend yield, Wells faces ongoing questions that threaten the viability of its future growth. Even if Wells can eventually get things back to normal, Bank of America is a more trouble-free bank right now with favorable prospects for the immediate future.
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