Income investing

Wells Fargo (WFC): Income Investing Alongside Warren Buffett

Wells Fargo & Co. (NYSE: WFC) is Warren Buffett’s second largest holding, accounting for about 18% of Berkshire Hathaway’s total portfolio, according to its latest 13F SEC filing. With a 3.26% dividend yield, income investors may appreciate the stock’s ability to pay a consistent dividend at a time when bonds are offering near-record low yields.

The popular bank also stands to benefit from a potential interest rate hike by the end of the year. Since higher interest rates translate to greater interest income for banks, the financial sector tends to outperform during periods of economic expansion and rising rates. 

The record low rates observed in today’s environment has left the sector in a holding pattern, but the Fed’s plans to raise interest rates by 1.3% in 2016 and 2.4% in 2017 could translate to higher profits over the long-run – making banks potentially attractive to own. 

In the company’s recent 10-Q SEC filing, it estimated that the Fed Funds rate would reach 1.86% over the next two years, which is a bit more bearish than the central bank’s own estimates. Higher rates could add up to 5% to its earnings, while the baseline case could result in EPS of $4.42 per share in 2016 – up from $4.15 per share last year. 

The company’s low price-book ratio also makes it a compelling value compared to other banks in the space. The financial sector took a hit over the past few weeks after the central bank opted to avoid raising interest rates following a dismal May jobs report. 

If the weak results turn out to be temporary in nature, the central bank may decide to continue hiking interest rates by the end of the year, which could help boost the financial sector. The risk is that the weakness will persist and the bank will opt to forego any rate hikes until next year. 

In the meantime, Wells Fargo’s valuation has created a compelling opportunity to purchase a leading bank at a reasonable price ahead of a potential economic recovery.