Wells Fargo Flunks Stress Test, Abandons Dividend

Wells Fargo

Almost all of the banks that just took the Federal Reserve’s stress test are allowed to continue dividend payouts. Wells Fargo didn’t fare so well, and their dividend is in detention.

Many companies live in fear of investors giving their stocks the big thumbs down if they even trim dividends, let alone cut them off. For better or worse, there are a lot of investors that hold dividends close to their hearts, where the value of these payments is somehow magical and spends much better than capital gains does, and cutting dividends does upset them and cause some to sell and depress the stock price.

If a stock like Wells Fargo attracts more demand because people value it for its dividend independently, where they add to the demand that either looks at price appreciation or total return, that will raise the price of your stock. As this diminishes, this does put you down at least somewhat.

Those who see dividends as milk and honey will be going without in the third quarter this year with Wells Fargo stock, much to their chagrin. It’s also to the chagrin of Wells Fargo as well, and given that the price of your stock is the bottom line these days, concerns abound about how the market will take this slap in the face to a fair number of holders of this stock.

Those who are interested in what the ultimate influence of this extra demand driven by dividends will get a great opportunity to see this in action now, and at least out of the gate, the crowd that many thought they would see on deck heading for the lifeboats is notably inconspicuous.

In the first trading day after Wells Fargo’s disappointing news, the stock rose by 1.42%. The market was up that day, but the market has mostly left Wells Fargo behind lately, so having them tag along at a time that so many were worried about a meaningful hit at least is particularly praiseworthy.

Wells Fargo’s chart is like going back in time, to a time when the market crashed and we were waiting for it to turn. Wells Fargo is still stuck on the runway waiting. Their trip downhill this year started on day 1, and they now barely sit above their March low marking the end of the main crash.

Wells Fargo is pretty sick right now, more so than the other major banks in the U.S., and their recent trip to the doctor, the Fed, has resulted in their dividend being issued a stay at home order while the bank is put under bed rest.

This was no real surprise, as Wells Fargo has been singled out as the stock most likely to lose their dividend as well as the bank with the stock that is most at risk among the big stocks in this sector.

While at least some of its lack of being able to raise itself off the ground is being blamed on the risk of losing the dividend, no one knew this for sure and there was enough of an element of surprise in Monday’s announcement to add at least a good measure more of this negative view if this actually contributed to the poor performance of the stock lately. Not seeing this happen at all suggests that the real reason was the health of the bank being so questionable and not dividend concerns.

Wells Fargo’s CEO Charlie Scharf also got to share some news that clearly does matter, that the bank’s losses next quarter are going to be larger than expected. Scharf did try to encourage continued confidence in the bank getting through these more troubled times, promising to maintain the focus on earnings, which are another thing that a lot of investors hold in high regard.

Wells Fargo’s value at $25 a share does not lie in the third quarter, or even for a few quarters, it’s where the bank is headed at least a little further out than this, such as the next 3 to 5 years. In spite of a terrible first quarter where they were expected to make 22 cents a share but only made a penny, they are still expected to make 72 cents this year.

This is expected to grow to $2.41 in 2021 and $3.72 in 2022, and compared to a stock price of $25, $3.72 a share is a pretty big chunk. Bank stocks are notorious for showing how little earnings can correlate with stock prices, for instance with record profits in 2018 causing bank stocks to go down rather than up that year, earnings still matter to some degree, and some degree has this going up a fair bit from the extra bashing they take when things actually do turn the wrong way.

It’s not that the market does not have these projections as well, but like the position the overall market was in after the big whack they took, Wells Fargo is being held back in school but are still smarter than the grade they are now stuck in.

Wells Fargo May Have Already Hit Bottom, But They May Do Some Real Time There

When a stock does not move down in a way that would be expected if this wasn’t almost over, this does suggest the potential for a bottom. When you already have put in a bottom over two months ago and have this support in place as well, this can at least serve to define our risk pretty tightly where we would escape if we broke through this, while providing us the several times this of upside that makes these trades sensible.

Those who take a longer-term view may also find this stock at least more appealing looking, and when you can buy it at less than half the price you could have at the beginning of the year, with nothing really that significant standing between them getting back to at least three quarters of their recent profitability within a couple of years, the numbers can be seen to lean at least a bit in Wells Fargo’s favor.

It’s not hard to find a low P/E ratio, understood by some as representing value, among bank stocks these days. Bank stocks are notorious for their greater value measured this way, and while some may see Wells Fargo as having enough of this additional value to pique their interest, this is not to suggest there is anything that special about it compared to their competitor’s stocks.

Not having to pay out a dividend is a good thing for a company, especially one facing so much near-term risk. We applaud this outcome, even though the bank had to be compelled by the Fed to do the right thing here.

There are also reasons to want to stay away from this stock whether you may be considering just trading it or jumping on board for a longer ride.

There won’t be any stock buybacks in store for this bank for a while, and buybacks help cushion the blow of bank stocks being generally more out of favor than your average stock in spite of how much money that they are making.

In addition to the big hit that they took this year so far, Wells Fargo has been in the midst of a downturn that goes back not just to the start of 2020 but the start of 2018. The better a stock has done prior to the pandemic, the better they have tended to respond post-panic.

Wells Fargo was one of the stocks that were struggling more before all this and therefore even being fully restored isn’t an exciting prospect and certainly below the threshold of what we should be looking for, the above-average potential for stock price growth that we need to be focused on as investors who are looking to succeed.

When you throw in all the additional business challenges that Wells Fargo and other banks are facing now in the aftermath, where default rates are expected to rise to levels that are at the very least concerning, if not disturbing, along with the decrease in business performance that this bank had already been stuck in a trend with, and the lack of favor that the market has shown this stock, even though this stock may bounce a little, this stock has little going for it compared to all the things that are working against it.

Over the longer run, if someone was looking to hold a bank stock, JPMorgan Chase looks like a more solid play, although the sector as a whole looks pretty weak right now and investors may be better served to at least wait until the recovery and the damage become more defined. We have a good idea of how this will look, and it doesn’t look that great for banks to be honest, with the potential of even more pain as we lift these tarps that we put on the economy and see how much harm we have actually done and how long it may actually take to rebuild things.

Unlike some sectors, the banking sector is at the bottom of the business pyramid and are the least insulated from macroeconomic damage, and have to bear the full weight of all the defaults upstream that flow right into their property. There are some pretty alarming things that are flowing down this river and they are heading right to the banks.

A Good Stock Isn’t About Just Getting By, It Needs to Be About Prospering

While the Fed does offer their hand in helping them over this if needed, to keep them solvent, remaining solvent doesn’t take you very far when the goal is the growth of your capital, to attract more people into the fold and not see a net migration away from it as we have seen lately.

Depending on how things go, it’s conceivable that this stock may make it back to the $33 area that it stalled at in both April and June, and like most stocks, it’s more likely than not that they won’t drop below their March lows, we then need to wonder how much more upside this will have over the rest of the year at least, what the chances are of their recovering the recent losses that they have suffered since June 8 when people started to worry about the coronavirus more.

Wells Fargo does sit 30% from where they were just three weeks ago, but in spite of this second wave of the pandemic being an illusion so far, since then we have also seen things like the expected default rate rising, Wells Fargo themselves forecasting bigger losses than expected, as well as their being singled out as the red-headed stepchild of the sector whose prospects are at least seen as dimmer by the market, and not without good reason as it turns out.

This doesn’t mean that we haven’t sold this stock off a little more than it has deserved, but this is at best a range bound play where we may not even get to the upper part of the range again this year depending on how things go.

As is the case with other stocks who have seemed to take a bigger hit than deserved over the last few weeks, the concerns that have set them back since then do need to dissipate before we should be too eager to play rebounds, where we need the rebound to start and have enough momentum to set it in the right direction enough.

As long as the fear level remains elevated, this is not the time to be too eager, and this especially applies to the bank stocks, and particularly does to Wells Fargo with their additional challenges. As this does eventually turn around, and if we really want to play a sector rebound, we may be better served looking to ride a more solid looking horse like JPMorgan Chase, who wasn’t sliding before this and did manage to recapture half of their losses from the crash prior to this second wave of fear.

JPMorgan Chase now sits with 20% of room to their June 8 level, and while this isn’t the 30% sized hill that Wells Fargo sees before them now, we also need to look at which bank is more likely to get back a good piece of this, and JPMorgan Chase has less garbage in their yard and appear to be in a better position to grow their stock price near term, as well has their better outlook over the next while at least.

The acceleration in testing that have driven these bigger case numbers and this greater level of concern that has accompanied it is slowing down, and given that we have only seemed to care about the number of cases, we might even see this fear dissipate as testing eventually slows down and the slowdown in the infection rate gets misrepresented on the downside the same way that it has been misrepresented on the upside as the testing increased.

The cases have plateaued now, although seeing them at double the June 8 number is going to bother people a lot in spite of this being not a valid way to understand the situation. We do have to wonder whether the media will see a decline in daily cases as any sort of positive, or just look for another way to distort the picture, where the threat of being deceptive has not only not served as a deterrent to deceive but even appears to be the primary goal.

Given that we’re told that hospitalizations in the country are going up now, which is not based on the facts either, together with all of the other misrepresentations and fear mongering they have promoted throughout this crisis, there’s no reason to think that they will abandon their strong desire to sensationalize this anytime soon.

They don’t tell you, for instance, that we had almost as many cases on Monday as the record we set 4 days ago, but the testing rate is accelerating so much now that we have almost doubled it in 4 days, from about 600 thousand then to 1.1. million now. If you get the same number of cases with almost twice the tests, the infection rate can only be understood to be rising if you have handed over your brain to the left-wing media, who are more than happy to fill it with all the garbage they can, including misrepresentations to scare you, getting you to support insurgency and chaos, and especially to hate Republicans.

While this sensationalizing has clearly spooked the market to some degree at various times, with stocks, this gets mixed with the desire for the market to be optimistic and the mix has had us moving forward up until this recent scare. Just like with the first wave of fear, this one will die down in time as well, and won’t take all that long given that it is a wave of fear of lesser magnitude.

Since banks have been particularly punished by this fear, they also stand to benefit more as it goes away, but we do get to pick what we go with to capture this effect. We might not want to be overly concerned with Wells Fargo cutting their third quarter dividends, it’s not that this is meaningless by any means, and together with their other issues, a coming bounce may be a playable move but there but may not be as playable as other choices and at the very least must be handled with kid gloves, as well as a sharp eye and mind.

John Miller

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.