In one of the earlier posts, I talked about the tools I use to monitor my stocks on a daily basis. You can read that post here: Part 1: My favorite personal finance and investment tools. It may seem excessive to some; however, I call it simply "keeping an eye on my investment portfolio" which I worked very hard to build. Also, I am not monitoring for price fluctuations but rather for any big events that may indicate trouble ahead or maybe a buying opportunity.
It's almost a habit of mine to check market and my stock positions and related news few times a day. This habit has saved me from big losses in the past and have saved me again when I saw the stock news yesterday about Wells Fargo bank getting fined $185 million by regulators for creating fraudulent customer accounts (see links to news later in this post). The news came as a big surprise to me as I had not seen any mention of pending investigation on the issue when I was researching the company few months ago and before buying its shares.
I have been reluctant to buy financials especially banks after what happened in 2008 and 2009. But a lot has happened since then and many of the big banks have recovered and doing quite well even in a low interest environment. Also, from pure valuation stand point, banks are looking pretty good. Given the interest rates are likely to go up soon, banks are to benefit most from rising interest rate environment and as a result their earnings are expected to grow over the years along with their stock price.
I wanted to own a small stake in financial/banking sector to take advantage of rising interest rate environment and after doing my due diligence on valuation and fundamentals, I bought a small position in Wells Fargo. I bought shares in Wells Fargo because it had the best valuation and overall solid fundamentals among its peers. Not to mention a nice 3% dividend.
Valuation methods are different for financial institutions than non-financial mainly because banks or financial institutions use debt as their asset or raw material which they then turnaround and lendout at a higher interest rate and make money on the interest spreads. Unlike non-financial institutions, banks report no capex, working capital, or debt. Therefore, it is difficult to calculate Free Cash Flow (FCF). Banks also use loss provisions to smooth out their earnings. Loss Provision is an accounting term where an entity would set aside a portion of their earnings each quarter/year in anticipation that a certain percent of loans are high risk and would default. Therefore, a conservative bank may not have a high earnings compared to its peers because it is setting aside more for loss provisions than the less conservative bank. As an investor, if I were to just look at the earnings, I would come to the conclusion that a bank with a higher earnings is doing great and likely a better investment which may not be true.
Anyhow, the point is that banks or financial institutions in general are a pain to evaluate as the accounting and valuation rules are different than non-financial companies. I went through quite a bit of trouble in understanding these differences in order to make a good decision when investing in Wells Fargo. Thankfully, I only bought a very small position as I was hoping for a better entry point.
Even though, my research convinced me I was buying shares in a solid and reputable company, it never occurred to me that thousands of employees at the biggest and most iconic bank could be involved in fraudulent activities. Here are a few articles from this morning that sum up the Wells Fargo saga:
Is Wells Fargo Rotten To The Core?
Wells Fargo Fined $185 Million For Opening Fradulent Accounts In Customers' Names
5,300 Wells Fargo employees fired over 2 million phony accounts
As of this morning, I have sold off all my shares in Wells Fargo at a small profit. I am very disappointed that I had to sell my shares but it was a matter of investing principles I follow. How are we to trust any financial reporting coming from them in future? I expect it to be a difficult road ahead for Wells Fargo as gaining trust back of their customers and investors is not going to be easy.
This is an example where no matter how fundamentally solid or reputable a company may seem, something rotten could be going-on underneath and when the rot surfaces up, as an investor you must be ready to take action as soon as possible to limit your loss and damage to your portfolio.