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Can Wells Fargo Sustain Its Premium Valuations?

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Wells Fargo’s stock performance

On April 14, Wells Fargo (WFC) reported its 1Q16 earnings per share at $0.99. It beat consensus estimates of $0.97. On a year-over-year basis, its earnings fell 5%.

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These large banks have the potential to impact the broader market indices including the S&P Index Futures (SPY) and corresponding financial ETFs. So far in 2016, shares of Wells Fargo underperformed the financial sector. Year-to-date, the financial sector lost 4.9%. In comparison, Wells Fargo lost 13%. The Financial Select Sector SPDR ETF (XLF) represents the financial sector. The first quarter earnings for the entire sector are expected to be dull, but analysts expected Wells Fargo to be hit less than its peers.

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Analysts expect upside in the stock

On April 15, the stock closed at $48.25. With an average consensus price target of $55.03, it’s expected to gain 12.3% in the next 12 months. Among the 37 analysts following the stock, 22 assigned “buy” ratings. Shares of Wells Fargo received ten “hold” ratings and five “sell” ratings. After the disappointing earnings, one analyst downgraded the stock from “buy” to “sell.”

Valuations

Banks use mark-to-market accounting. Their book values are a good indicator of their asset values. Banking stocks are generally valued on the basis of their book values.

Wells Fargo’s book value grew twice as much as JPMorgan Chase (JPM). It grew ten times more than Bank of America in the past ten years. It has been one of the most profitable banks in the US. It generated a 1.3% return on assets in 2015. The fact that it relies less on investment banking and trading activities makes it less risky in the current conditions. Interest rate hikes could act as a positive catalyst to its earnings.

Currently, Wells Fargo trades at a premium to its peers in the banking space.  However, analysts expect this valuation gap to shrink after its disappointing earnings. Shares of the company trade at a price-to-book multiple of 1.4x. It’s valuable compared to its peers JPMorgan Chase (JPM), Citigroup (C), and Bank of America (BAC). Currently, banking stocks within XLF trade at 1.02x their book value. This translates to a valuation gap of 0.4x for Wells Fargo.

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