Navigating Challenges With Calculated Growth In Banking And Investment

Key Takeaways

• Diversification of income with strong fee-based revenue growth in investment services and banking technology investments aimed at improving client retention.
  
• Expansion in credit card and corporate investment banking sectors indicates strategic growth efforts, likely enhancing future profitability and earnings.
  
• Anticipated rate cuts, high inflation, regulatory scrutiny, potential credit losses in real estate, and costs from strategic investments pose challenges to profitability and growth.

Catalysts

A financial services company, provides diversified banking, investment, mortgage, and consumer and commercial finance products and services in the United States and internationally.

• Strong fee-based revenue growth across investment advisory, trading activities, and investment banking is expected to offset declines in net interest income, contributing to an overall revenue increase. This suggests a diversification of income sources beyond traditional banking, which could bolster earnings.
  
• Efforts to transform and optimize the Wells Fargo branch network and invest in technology for enhanced digital banking experiences are set to improve client retention and attract new customers, potentially leading to higher revenue and profitability through increased product uptake and service usage.
  
• Expansion of the credit card business with new competitive offerings, as evidenced by strong credit card spend and new account growth, represents an investment in a higher-margin business that is expected to contribute meaningfully to future profit growth, positively affecting net margins and earnings as the portfolio matures.
  
• Progressive growth and investment in the corporate investment banking segment, with strong growth in investment banking fees, indicate strategic moves to capitalize on new opportunities for growth, which could lead to enhanced revenue and earnings.
  
• Continued enhancement of the Wealth and Investment Management business through improved adviser retention and focus on serving independent advisers and consumer banking clients is likely to drive growth, impacting revenue positively.
  These catalysts collectively signify strategic initiatives and operational improvements expected to support future growth in revenue, net margins, and earnings for Wells Fargo, potentially making the stock undervalued considering its future earnings potential.

Assumptions

• Analysts are assuming Wells Fargo's revenue will grow by 3.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 22.4% today to 22.8% in 3 years time.
• Analysts expect earnings to reach $19.9 billion (and earnings per share of $6.43) by about October 2027, up from $17.6 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $17.7 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.7x on those 2027 earnings, which is the same as it is today today. This future PE is lower than the current PE for the US Banks industry at 11.4x.
• Analysts expect the number of shares outstanding to decline by 6.97% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.15%, as per the Simply Wall St company report.

Risks

• The anticipation of rate cuts could impact net interest income negatively by reducing the yield on earning assets and contribute to tepid commercial loan demand.
  
• High inflation and elevated interest rates pose economic headwinds that could affect consumer and business spending, potentially leading to reduced demand for banking services and impacting revenue.
  
• Heavy regulatory scrutiny and the risk of further regulatory actions could result in additional compliance costs and restrictions, negatively influencing profitability.
  
• Credit losses in the commercial real estate sector, notably in office properties due to deteriorating fundamentals, may lead to increased provision expenses, impacting net margins.
  
• Strategic investments in new credit card products and business expansion entail significant upfront costs with uncertain returns, potentially affecting short to medium-term earnings growth.

Valuation

• The analysts have a consensus price target of $63.4 for Wells Fargo based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $70.0, and the most bearish reporting a price target of just $57.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $87.5 billion, earnings will come to $19.9 billion, and it would be trading on a PE ratio of 10.7x, assuming you use a discount rate of 7.2%.
• Given the current share price of $55.39, the analyst's price target of $63.4 is 12.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.