Last week Wells Fargo (WFC) reported better than expected first quarter EPS of $0.55/share. If the company manages to maintain earnings at the current rate, the annual EPS would jump up to $2.20/share. That puts the forward P/E ratio at 9, which is pretty low, and makes the stock pretty attractive at current levels.
At the same time however Wells Fargo has cut its quarterly dividends from $0.34/share to $0.05/share. At the current stock price shareholders are getting a mere 1% yield. If things were really as great as the most recent quarterly report suggested, then the dividend should not have been cut so severely.
Dividends are typically real cash that companies pay out to their shareowners. Unlike earnings, which could be manipulated back and forth to show rosy sand castles, dividends are real cash that cannot be created out of thin air. Thus management commitment to a dividend policy of consistent increases shows confidence in the business model of the company and its ability to allocate cash flows effectively.
If the situation was that great at Wells Fargo, then the company doesn’t expect these record profits to be sustained over the course of the next few quarters, based off the severity of the dividend cut in March. Now some analysts would claim that the dividend cut was necessary in order for Wells Fargo either to have the cash to repay the treasury’s TARP money earlier, to maintain its Tangible Common Equity Ratio, or to conserve cash as financing is difficult to obtain during a credit crunch.
Even if management really believed that operating momentum is sustained and that annual earnings per share would grow at double-digit rates, unless the board decides to share the new prosperity with shareholders by raising the dividends or buying back stock, investors have few tangible options to profit from the prosperity. Of course stock prices could go higher if earnings go higher, but that’s not always the case. If you are betting on the greater fool theory to profit in the stock market however, you might join the crowd of 90% of active traders who consistently lose money. If you want to invest intelligently and not speculate blindly, you would pass Wells Fargo at this moment.
I do have high hopes for the company and would consider purchasing stock in it when the dividend growth policy is re-instituted. Until then there are many other opportunities for slow and steady total returns with much less risk considering.
Full Disclosure: None
Relevant Articles:
- The Dividend Edge
- Wells Fargo Joins the Crowd of Dividend Cutters
- TARP is bad for dividend investors
- Which Bank will be next? Follow the dividend cuts
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