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Why This Bank Is a Buy Ahead of Earnings, 40% Premium On The Way


In a recent discussion about the current status of the financial sector, Warren Buffett said, “I like Wells better than anything, by far.”  The oracle was, of course, referring to Wells Fargo (WFC). I was taken aback by this endorsement -- considering that Buffett has recently invested $5 billion in rival Bank of America (BAC). Buffett understands that since that dark period of credit crisis, Wells Fargo has cleaned up its messes arguably better than anyone. Suffice it to say, when Buffett speaks, the market listens. And as evidenced by Wells Fargo’s recent performances, he continues to be proven right. Q3 Was Beyond 'Well' The bank reported net income of $4.9 billion or 88 cents per share. It was a year-over-year increase of 22% with a 27% sequential improvement. Not only was profitability a company record, but it also continued its streak of profit growth to 11 quarters. Likewise, revenue was solid – coming in at $21.2 billion, or year-over-year growth of 8.2%. The bank continues to enjoy improved returns on its assets and investments, which reflects a sign of solid execution and leverage. What’s more, that deposits outpaced loans (3% vs. 2%) allows the bank the sort of liquidity needed to generate returns from any potential investments it sees fit. However, that it missed revenue estimates was a concern. Then again, the adverse issues were broad and impacted the entire sector, including JP Morgan (JPM) and Citigroup (NYSE:C). For that matter, from the standpoint of execution, Wells still outperformed them both. For instance, although JP Morgan beat top and bottom line estimates – reporting $1.40 per share on revenues of $25.9 billion – on percentage basis, Wells Fargo’s 8% revenue growth and 22% surge in profits outpaced JP Morgan’s growth of 6% and 15%, respectively. Likewise, Wells Fargo exceeded Citigroup, which posted $19.4 billion in revenue, which also represented a year-over-year decline of 7%. On the other hand, Citigroup still managed to beat both top and bottom line estimates. Nonetheless, all of these point to the fact that Wells has been growing and stealing market share from its rivals. And the trend is expected to continue. Expectations for Q4 The bank will report fourth quarter earnings on Friday before market opens. The Street will be looking for earnings of 89 cents per share on revenues of $21.29 billion. While this will represent 22% profit growth, it does reflect a 3% sequential decline in revenue. Then again, it would be a 3% improvement year-over-year. During the conference call, investors should pay close attention to mortgage-related details. As it stands, Wells enjoys a 33% lead in loan originations. With modest improvement in the housing market under way, this would be an extra boost to the bank’s bottom line and build on its Q3 momentum, during which Wells secured $10 billion in mortgage originations. Remarkably, the bank’s solid performance was despite adverse climates caused by weak long-term interest rates. But on the other hand, its business is unburdened from the various types of risks that have hurt its peers, including derivatives, investment banking, prop trading and adversities of Europe. Bottom Line Wells Fargo has an excellent brand. And as shown in its mortgage performance where it is stealing share from JP Morgan Chase and Bank of America, Wells still has many more opportunities to grow. On that basis, I expect the stock to continue to outperform and reach a price of $40 at some point in 2013 – representing a 20% gain. Oh and by the way, despite Wells Fargo’s dominant showing in the financial sector, it was Bank of America that outperformed the entire group in terms of its stock – gaining $110% in 2012. What this means is - Buffett was still right.