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Pros and Cons to Buying Wells Fargo Stock

John Divine

Despite being one of the nation's largest banks, Wells Fargo & Co. (ticker: WFC) enters 2020 with a three-plus year hangover. The fake accounts scandal that rocked the financial powerhouse continues to plague Wells Fargo, and its share price is showing some wear and tear as a result.

Its primary problems are on the regulatory front and with customer and investor perceptions, which have been mostly negative. Specifically, it's still working to recover trust after a 2016 scandal in which it created as many as 3.5 million phony credit card and bank accounts for customers without their consent to boost sales figures and make more money.

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The bank lost billions in market capitalization, fired 5,300 employees and was publicly scolded on Capitol Hill, where members of Congress berated CEO John Stumpf and accused the bank of breaking the trust of its customers. Stumpf retired from the bank weeks later.

But headwinds linger for WFC stock.

In early 2018, the U.S. Federal Reserve announced that it would limit Wells Fargo's growth to just under $2 trillion in assets until the bank "sufficiently improves its governance and controls." The Fed also required Wells Fargo to replace four board members by the end of the year.

Wells Fargo Stock at a Glance

Founded in 1852 and headquartered in San Francisco, Wells Fargo operates 7,600 locations and 13,000 ATMs, along with offices in 32 countries.

In the last year, WFC stock is up only 1% while its major competitors -- Bank of America Corp. ( BAC), Citigroup ( C) and JPMorgan Chase & Co. ( JPM) are up between 15% and 19%.

Although Wells Fargo's initial reaction to the 2018 Federal Reserve limit on asset growth was to express confidence in its ability to improve its governance and controls, the asset limit is still in place nearly two years later. Wells Fargo is undergoing a restructuring, still dealing with legal repercussions and is on its third full-time CEO since the 2016 scandal hit its reputation.

Early on, the bank had publicly said that it expected the asset cap to only be in place until the beginning of 2019, but the limit will now last at least until the end of 2019, if not longer.

And while ratings agencies acknowledge that Wells Fargo is in a generally strong financial position, Standard & Poor's cut the bank's credit rating from "A" to "A-" in 2018.

Pros to Buying Wells Fargo stock

There is a silver lining to the 2016 fake accounts fiasco and subsequent fallout. As far as its reputation is concerned, there's a school of thought that the storm has largely passed for Wells Fargo and that any negative blowback is already baked into the cake.

"While the bad news is not good, the truth is that the customers who were going to leave Wells Fargo due to the scandal have for the most part already left," says Michal Strahilevitz, an associate professor of marketing at Saint Mary's College of California.

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Financially speaking, there are some positives for WFC shareholders, even if they're somewhat scarce. While the $2 trillion Fed asset limit remains in place, the bank is focusing on returning capital to shareholders; Wells Fargo bought back $9 billion in stock last quarter, up 2% from the year-ago period. And the dividend payment was hiked as well, jumping a healthy 19%.

Due to steady stock buybacks, the share count is down 9% from a year ago, giving shareholders a bigger slice of the pie. And the upside to a largely stagnant stock price is a fairly robust dividend yield, which currently clocks in at 3.8%, well above other high profile megacap banks in its peer group. That dividend is also more than sustainable, as the company uses just 39% of its earnings to finance it.

Cons to Buying Wells Fargo Stock

Wells Fargo may face a long uphill climb in terms of both customer and shareholder trust, and while time heals all wounds, there are likely better options out there in the large bank sector.

That's especially so in an increasingly robust economy, where investment banks like Goldman Sachs Group ( GS), Bank of America and JPMorgan aren't shackled, regulatory-wise, like Wells Fargo. A better economy translates into stronger banking bottom lines in lending, which helps WFC's competitors, who stand to benefit from loan customers leaving Wells Fargo.

By and large, WFC's competitors aren't fighting any corporate culture and customer trust battles, and that counts for a great deal in a market environment where optics matter.

Unfortunately, the optics get worse when looking back on the post-scandal saga of Wells Fargo. By 2019, it might've seemed to the typical shareholder that the fallout from the 2016 fiasco was firmly in the rear view mirror. Then, the relatively new CEO who took over in 2016, Tim Sloan, abruptly announced his resignation in March.

S&P almost immediately downgraded the credit outlook to negative from stable, citing the uncertainty it raised, and noting that Sloan's resignation raised concerns over WFC's ability to meet the levels of risk management required for regulators.

But enough intangibles; those fears proved well-founded, with a fresh $1.6 billion litigation charge hitting the company in the third quarter of 2019. Also, net income that quarter fell 23%, or $1.4 billion.

Return on tangible common equity fell from 14.33% to 10.7% and return on assets slipped from 1.27% to 0.95% in the most recent quarter. The efficiency ratio, or the percentage of revenue eaten up by expenses, rose to 69.1% from 62.7%.

On top of that, Wells Fargo has closed roughly 1,000 locations in the last year or so, and WFC stock is virtually unmoved in both trailing 3- and 5-year periods. Going forward, the consensus price target is at $54, implying there's no upside in the stock at current levels.

The Bottom Line on WFC Stock

The cons far outweigh the pros for Wells Fargo stock.

Faith in Wells Fargo's ability to prove it has changed and rebound from its brazen 2016 fake accounts scandal has been continuously punished. The greatest investor of all time, Warren Buffett, is, through the holding company he helms, Berkshire Hathaway ( BRK.A, BRK.B), selling shares, reducing Berkshire's stake by 7% in last quarter alone.

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The Federal Reserve mandate remains a stubborn cap on the company's growth prospects. With no concrete evidence that Wells Fargo has turned a new leaf, it would be silly for investors to handicap themselves by investing in a company that can't grow its assets.

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