Investors seeking premier Main Street banking stocks with excellent long-term income and capital appreciation prospects, without the Wall Street razzle-dazzle accounting, derivatives and trading desks may want to look at Wells Fargo & Co (NYSE:WFC) and U.S. Bancorp (NYSE:USB).
Winning bank stocks often fit the following criteria:
- Strong return-on-equity and return-on-assets versus industry peers
- Excellent financial strength as defined by Tier 1 equity ratio
- Strong expense management as defined by efficiency ratio
- Clearshareholder return-of-capital policy; and a good runway for forward dividend growth
Both banks rank within or very near the top for return on equity and return on assets.
The following chart, taken from a recent Wells Fargo investor presentation, highlights ROE and ROA performance as compared to large banking peers:
When evaluating a bank’s financial strength, the Tier 1 common equity ratio can be effective; it’s also utilized by Federal regulators.
The Tier 1 ratio is a measurement of a bank’s core equity capital compared with its total risk-weighted assets. The Tier 1 common ratio excludes preferred shares and non-controlling interests when determining the calculation. A firm’s risk-weighted assets include all assets that the firm holds — systematically weighted for credit risk.
Central banks typically develop the weighting scale for different asset classes, such as cash, which has zero risk, versus various securities, which carry greater risk.
Here’s the 2013 2Q results for the two banks:
- Wells Fargo: 10.73%
- U.S. Bancorp: 9.21%
A company must have a Tier 1 ratio of 6% or greater to be classified as well-capitalized.
Both Wells Fargo & Co (NYSE:WFC) and U.S. Bancorp both make the grade by a wide margin.
Expense efficiency ratio
Within the banking industry, the efficiency ratio is calculated by dividing non-interest expenses by revenue — a lower number is better. For example, if a bank spends $100 million and generates total revenue of $150 million in a month, its efficiency ratio is 67%. Banks desire a lower efficiency ratio because this means it’s making more than it’s spending.
Here’s a look at Wells Fargo’s non-interest expense and efficiency ratio:
The story looks very similar at the Minneapolis, Minn.-based U.S. Bancorp:
Notably, U.S. Bancorp has maintained the lowest (and therefore the best) ratio of any of the major U.S. banking institutions.
Shareholder return of capital
Historically, banking stocks are sought for long-term, steady earnings growth and consistent return of capital. Shareholder capital returns are provided via dividends and stock repurchase plans.
Wells Fargo and U.S. Bancorp are noteworthy not only for their sound and growing post-recession stockholder returns, but the clarity by which management communicates targets and executes them.