Last May 26, I predicted that in 12 to 18 months, we would look back at American banks as having been the no-brainer buying opportunity of the COVID-19 crisis.
Two specific factors made me extremely bullish on U.S. banks at the time…
- The banks entered the pandemic with incredibly strong balance sheets – in perhaps the best financial shape the industry has ever been in. I believed that this financial soundness left the banks more than able to handle the loan write-offs that the pandemic would create.
- The banks were dirt cheap. In fact, the sector was just as inexpensive as it was during the depths of the 2009 financial crisis, when banks were going out of business on almost a daily basis.
The banking sector deserved to be beaten down in 2009.
This time, it didn’t.
I did stress at the time, though, that bank stocks were not a short-term trade.
I expected that the banks would have a rough stretch of earnings that could last 12 to 18 months because there would be bad loans to be written off.
That said, I believed that the banks could recover to where they were trading pre-pandemic because their earnings would recover.
I identified the SPDR S&P Bank ETF (NYSE: KBE) as a diversified way to take advantage of this opportunity in banks.
I even went out on a limb and gave a very specific prediction…
If bank share prices follow earnings back up, the SPDR S&P Bank ETF would see a move from $29 today to almost $50, which represents 72% upside for the entire sector.
Here we are 11 months later, and I’m happy to say that the SPDR S&P Bank ETF has arrived at our $50 price target ahead of schedule.
The exchange-traded fund (ETF) actually reached $55 in March, so we even passed our desired destination.
Even better, the ETF has widely outperformed the overall market.
While the S&P 500 is up 39%, the SPDR S&P Bank ETF is up 76% – almost double the return.
With so much upside now behind us, I think most of the banking sector is getting pretty close to fairly valued.
There is still some upside left, but with the entire sector up by 75%, the easy money has been made.
My Favorite Bank Still Has Room to Run
I singled out one individual bank as having the most upside for investors…
This one took a little longer to work out, but it was worth the wait.
I was referring to the $10 billion annual expense reduction that Wells Fargo CEO Charlie Scharf had just told the public was achievable over the next couple of years.
Note that a normal year of earnings for Wells Fargo in recent years is $20 billion. Therefore, that $10 billion of expense reductions would mean a 50% boost to Wells Fargo’s total income.
In addition to the $10 billion of expense reductions that are coming, I also loved Wells Fargo’s stock back in September because it was incredibly cheap.
At the share price of $25, Wells Fargo was trading for barely over 60% of book value. Historically, the bank has traded at almost twice that multiple – closer to 120% of book value.
Since September, Wells Fargo’s share price has gone on a tear. With the stock now well over $40, our favorite bank has more than tripled the S&P 500’s performance over that time.
And while I think the banking sector overall is no longer a table-pounding “Buy,” I do think Wells Fargo has more room to run.
With Scharf’s $10 billion of expense reductions still to come, I think Wells Fargo could generate annualized earnings of more than $6 per share by the end of 2022.
At a conservative price-to-earnings multiple of 10, that would put shares of Wells Fargo at more than $60, which is almost 50% higher than where it sits today.