Wells Fargo

Wells Fargo
Name
MBA 570-CHB
Corporate Finance
2015 FA1
Abstract
This is an analysis of financial ratios, stock prices, as well as an assessment of the required rate of return using the DCF approach. The information was collected from the financial records of Wells Fargo and Co focusing on the income statements and Statement of financial position for the years 2011 to 2015. The main purpose of the study was to collect the most relevant information to make decisions on whether it is worthwhile to invest in the company. Subsequently, suing the DCF model showed that investors ought to buy the stock, which has the possibility of rising over time. The Capital Asset Pricing Model – (CAPM) to determine the risk premium, which represented the expected return above the risk free rate, with the expected rate of return being 1.45%.
PART 1
Introduction
Wells and Fargo mainly operate in the U.S. in the financial services sector, providing the services in the consumer, banking, mortgage, investing and credit cards. Wells Fargo has operations in more than 35 countries, with operations divided into the wholesale banking, community banking, wealth as well as brokerage and retirement segments (Wells Fargo, 2015).
The financial analysis will focus on ratio analysis, and stock analysis, and this is relevant to making decisions about the company. There are various users of financial information, whereby creditors and investors focus more on the financial information to assess the viability of the company.
Methodology:
The information was collected from largely collected form  HYPERLINK "" , and  HYPERLINK "http://finance.yahoo.com" http://finance.yahoo.com, focusing on the financial information pertaining to the income statement and balance sheets. In cases where the financial ratios were not provided, they were calculated from the available information covering the years 2011 to 2015. This was necessary to compare the results and determine and emerging patterns. Information on stock analysis was also based on past information, but also integrated information on expectations about the growth in the company’s dividends and earnings per share.
Financial Analysis
2014201320122011Assets1,687,1551,527,0151,422,9681,313,867Liabilities (Debt)183,943152,998127,379125,354Equity184,394170,142157,554140,241Sales84,34783,78086,08680,948Operating Costs50,43251,15157,61557,292
The assets and equity of Wells Fargo increased from 2011 to 2015, but the sales increased from 2011 to 2012, but then increased in 2013 and 2014. On the other hand, the operating costs decreased from 2012 to 2015, after initially rising in the years 2011 to 2012. The implication is that it was possible to manage the operational costs. The change in assets is one that cannot be controlled by the management as they dedicate funds for such investments. However, the sales level was not controllable hence the changes in the revenue. Even though, the operating costs fell as the sales declined, the costs were controllable compared to sales.
b] Internal Liquidity
Wells Fargo did not provide total current assets, but the cash and cash equivalents are assumed to represent the total of the current assets. Both the current and quick ratio indicate the ability to meet short-term obligations as they fall due, and also represents ability to maintain solvency The current and quick ratios are all below 1.0 indicating that the company may face problems to meet its financial obligations. Well Fargo’s management then has to focus on whether there is a possibility of better long-term prospects as this affects their borrowing ability. The ratios also rank lower than the industry median.
2] Operating Performance:
2014201320122011PM25.8724.9320.9118.56EPS4.10
3.89
3.362.82ROA1.361.421.321.17ROE13.6813.9913.1612.19
The profit margin (net margin) is dependent on the net income (sales) and expenses focusing on the core business of Wells Fargo after paying for all the expenses. Since the ratio measures how an organization profits compare to the sales, it is useful in measuring past profitability performance while comparing with the industry average. The performance is well ranked compared to the global industry in 2014, and since the margin expanded for the four years there is improved profitability. Even though, the net income may take into account non-recurring items, amortization, depreciation and depletion, the measure is still useful to indicate Wels Fargo competitiveness in the long-term.
The earnings per share (EPS) is the ratio of net income less preferred dividends divided by the total shares outstanding. The EPS increased from 2.82 to 4.10 in 2011 and 2014 respectively. Despite the EPS growing, it has grown at a decreasing rate, rather than a constant rate. The EPS is an important indicator of the potential earnings power, but investors look not whether there is a risk of financial manipulation through adjusting the non-recurring items amortization and depreciation. As such, it is necessary to look at the EPS together with the cash flow to understand Wells Fargo earning power.
The Return on Assets (ROA) is the ratio of net income to the average total assets, and although the rate rose from 2011 to 2013 it fell to 2.36% in 2014 compared to 1.42% in 2013. Nonetheless, the annualized ROA is still higher compared to the industry median. The ROA measures an organization’s efficiency when generating profits by taking into account the returns on total assets, which are equal to the shareholder equity and liabilities (Wahlen, Bradshaw & Baginski, 2014). Investors seek higher returns, but the share/ stock back returns money to the shareholders, but the company can also buy shares from the open market and potentially m’ manipulating the financial ratios like the ROA.
The Return on equity (ROE) is the ratio of net income to the average shareholder equity, and similar to the ROA it increased from 2011 to 2013 but then decreased in 2015. The company’s performance in 2014 at % is better than the industry average and ranks high among similar businesses. The profitability and efficiency ratio measures the ability to generate profits from the shareholders’ equity. Higher ROEs are desirable, and the ROE is dependent on the net profit margin and the asset turnover. Since company earnings directly influence the ROE, it is necessary to assess the ratio by taking into account the business cycle and changes in earnings.
2 ii] Asset Management ratios
2014201320122011Asset Turnover0.050.050.060.06DSO----Inventory Turnover----
Asset turnover
The asset turnover is the ratio of sales (revenue) to total assets and in cases when there are higher profit margins there are lower asset turnover. The asset turnover was consisted in 2011 and 2012 at 0.06 and 0.05 in the years 2013 and 2014 (Morning Star. com, 2015). Higher asset turnovers ratios are preferable, and although the ratio declined marginally there is no concern that the company will be unable to use the assets efficiently. The ratio is important to creditors and investors as they seek to understand how Wells Fargo manages the assets to spur revenue growth.
The inventory turnover represents the speed with which an organization moves its inventory, as it is the ratio of the cost of goods to the inventory (Wahlen, Bradshaw & Baginski, 2014). However, Wells Fargo did not indicate the levels of inventory it was not possible to determine the inventory turnover. Typically, the inventory turnover is not applicable to organizations in the financial service sector. The Days’ Sales Outstanding ratio (DSO)/ average collection days represents the average number of days that a business collects the trade receivables. However, there was no indication on the credit sales. This would have made it easier to assess the company’s efficiency in converting sales into cash, and lower values are preferred.
3] Risk Analysis:
Financial Risk: Discuss debt-to-total assets, debt-to-shareholders’ equity, TIE, and cash flow coverage
2014201320122011Debt-to-Assets0.110.100.100.10Debt-to-Equity1.110.990.880.97TIECash Flow CoverageThe debt-to-total assets ratio is a percentage of the long-term debts divided by the total assets, indicating the component of assets financed using long-term loans. The ratio increased marginally from 0.10 to 0.11 in the years 2011 to 2014. The company is dependent on long-term loans to grow its business, and a lower ratio is even preferable. Since the ratio indicates the financial position of the company there is no concern on using debt financing.
The debt-to-shareholders’ equity is the ratio of total liabilities to stockholders’ equity and bondholder are more interested in the ratio, as it indicates the value of liabilities. The debt-to equity ratio in 2014 was the highest for the four years at 1.11, and this indicates that Wells Fargo increased the level of debt financing. This resulted in higher interest expenses but has no effect on earnings volatility as the level of debt financing is still manageable.
The Times interest earned (TIE)/ fixed-charge coverage ratio is the ratio of earnings before interest and taxes divided by the interest expense of the long-term debt. Since the earnings change over time, companies need to have adequate earnings to cover the interest expense. Investments in a company with low earnings compared to interest expenses are a risky venture in case a company fails.
The cash flow coverage ratio is a form of earnings based ratio, whereby companies pay debts using actual cash rather than earnings (Baker & Powell, 2005). Cash flows are preferred as they provide a better indication on the company’s ability to meet obligations. The cash flow coverage ratio is calculated as the sum of the earnings before interest and taxes and depreciation divided by interest expense.
4] Stock Price Analysis:
DateWFC3-Jan-1131.5830-Jun-1128.0630-Dec-1127.5629-Jun-1233.4431-Dec-1234.1828-Jun-1341.2731-Dec-1345.430-Jun-1452.5631-Dec-1454.82
DateS & P 5003-Jan-111,271.8730-Jun-111,320.6430-Dec-111,257.6029-Jun-121,362.1631-Dec-121,426.1928-Jun-131,606.2831-Dec-131,848.3630-Jun-141,960.2331-Dec-142,058.90




The Wells &Fargo stock price has changed between 2011 and 2014 rising and falling but mostly has been on an upward trend. As such, this is a hold and buy type of stock while its performance does not deviate from the S & P 500 index. The price target for the 12 month is $ 60, but there is a need to take into account the earnings growth since the forecasts is a also depedent on the economic performance. Even though, the share price indicates the movement over time, earnings and EPS are integral components of the stock analysis.
5] Required Rate of Return Analysis: Using the CAPM,
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Risk free rate- 30-year Treasury bond 2.96%Market return- S & P 500 -1.83%Stock beta 0.92
Using the CAPM then
Required Rate of Return Analysis/ Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market - Risk-Free Rate of Return
=2.96+ 0.92*(-1.83%-2.96%) =-1.45%
Equity market premium=-4.79%
Expected return on capital asset=- 1.45%
The DCF model works best when focusing on the long-term perspective since there is adequate market time to correct valuation mistakes (Fabozzi, 2009)The expected market return for one year at -1.83 % has resulted in the required rate of return being negative. However, this result is based on market expectations for a year, while that of the past year has been positive, as are for the month. Nonetheless, this is lower than the long-term average, indicating that the S & P 500 1 year return may not necessarily be the most appropriate.
6] Stock Valuation: Using the DCF model
Perpetuity Value =
(CFn x (1+ g)) / (R - g)
CFn = Cash Flow in the Last Individual Year Estimated, in this case Year 10 cash flowg = Long-Term Growth RateR = Discount Rate, or Cost of Capital, in this c...