We’ve now heard 2018 year-end results from all of the big U.S. banks, and with the sector underperforming the market significantly over the past year or so, it’s a good time to look for bargains.
Two bank stocks that look attractive right now are Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC). The former trades for a significant valuation discount relative to peers, while Wells Fargo has been beaten down in recent history thanks to its numerous high-profile scandals and resulting penalties. Here’s a quick rundown of where the two banks stand, and which could be the better choice for your portfolio now.
Image source: Getty Images.
Bank of America: Now a top-quality bank
Bank of America isn’t the same bank that was struggling to recover from the financial crisis just a few years ago. Under the leadership of CEO Brian Moynihan, Bank of America’s focus on asset quality, efficiency, and embracing technology has transformed it into one of the best-in-breed U.S. big banks.
For example, if I had told you seven or eight years ago that Bank of America would have a return on equity (ROE) and return on assets (ROA) of 11.6% and 1.24%, respectively, both of which are well ahead of industry benchmarks, you would have called me crazy. In fact, you may have been surprised to hear that those metrics were even positive. Yet, here we are.
The same can be said for Bank of America’s 58% efficiency ratio, the fact that the bank spent a staggering $20.1 billion in repurchases last year (which was approved by regulators), and that the bank would have an industry-leading technology platform.
Bank of America continues to grow impressively and to expand its revenue stream into new areas. For example, the Merrill Edge brokerage platform’s assets actually grew by 5% during the fourth quarter despite dismal stock market performance thanks to a remarkable $25 billion in net inflows.
Wells Fargo: A strong bank, but the drama lingers
Despite the scandal-plagued nature of the past few years, it’s important to understand that Wells Fargo is still an incredibly strong financial institution. As my colleague Jordan Wathen recently discussed, Wells Fargo’s asset quality remains strong with a minuscule 0.30% net charge off rate, and its deposit costs haven’t risen nearly as quickly as many other banks. Plus, it’s the only one of the “big four” U.S. banks that is a purely commercial bank (no significant investment banking revenue), so its business is generally more predictable and easier to evaluate.
Now, it’s been a while since the infamous fake-accounts scandal was revealed, and to be fair, there haven’t been any new issues announced recently. And, CEO Tim Sloan is doing a good job of trying to rebuild the bank’s public image.
However, there’s one big question mark that concerns me as an investor. Wells Fargo is not allowed to grow. Because of its numerous scandals, the Federal Reserve imposed an unprecedented penalty on the bank, prohibiting Wells Fargo to grow beyond its size as of the end of 2017. And, it remains completely unclear when this restriction could be lifted.
In other words, despite being an overall strong financial institution, Wells Fargo isn’t allowed to grow while we’re in arguably the best growth environment for banks in decades. That’s a big red flag to me as a long-term investor.
The valuation isn’t what you might expect
After reading the last two sections, you might think that Bank of America is the more expensive of these two bank stocks, but you’d be wrong. In fact, Bank of America trades for a significant discount to Wells Fargo on a price-to-book comparison.
BAC Price to Book Value data by YCharts.
To be clear, there are some valid reasons for this. Investment banking, which Bank of America engages in but Wells Fargo doesn’t, is generally considered a more volatile business and often commands a lower valuation. For context, leading investment banks Goldman Sachs and Morgan Stanley trade for 0.81 and 1.02 times book value, respectively.
Plus, while Bank of America’s asset quality has improved tremendously, I wouldn’t exactly put the bank on the same level as Wells Fargo — not yet, anyway.
In my mind, Bank of America is the clear winner here. Not only has its quality and efficiency improved to the point where it’s one of the best big U.S. banks, but it also trades at a significantly cheaper valuation than Wells Fargo. And, don’t forget that Wells Fargo isn’t currently allowed to grow. Full disclosure: Bank of America is a staple of my own stock portfolio, and if I decided to buy one of these today, the decision would be simple.