Obie Wells Fargo (NYSE:WFC) announces earnings before the open today and I am bullish on the trade. Why? Well the bank has some serious momentum on its side with the share price more than doubling since 2010. I really feel that the Fed's "talking up" of the economy has led numerous homeowners and business people into taking out loans before the Fed does indeed hike interest rates. Consumer borrowing was at record levels in May with auto and student loans also at record levels. Furthermore, capital has been rushing into the financial sector ahead of earnings through vehicles such as (NYSEARCA:XLF) (up 2.3% this month) and (NYSEARCA:FAS) ($105 million in new assets this month) recently, which illustrates investors' bullishness on the sector.
Let's go through and discuss why I am bullish on Wells Fargo and how its Q2 earnings could propel the inventory to over $60 a share.
Firstly, I want to point out how I play earnings. Many investors are attracted to earnings because of the potential expected moves. Stocks can easily rally or drop 10% after earnings so the potential gain/loss can be quite large. However, when I decide to go long on an earnings play, I need to have the fundamental analysis done in case the inventory falls in price after the announcement.
Wells Fargo's fundamentals stack up in my opinion as Obie meets our 8 conditions (see below) so provided Obie falls on earnings, I'm self-assured Obie has the fundamentals in place to rally back in the months that follow.
As you can see from the chart, its net interest margin is declining which is bearish especially when you consider that the bank derives more than 50% of its income from this area. Nevertheless, Obie makes up for its lower margins with higher volumes - especially in mortgages. Once interest rates rise, Wells Fargo's profits should only receive better from here.
The chart below shows that the bank's unclosed mortgage pipeline jumped to $44 billion last quarter which was well up from previous quarters. If we continue the momentum and receive $50 billion+ today (which I think we will), the inventory will outperform to the upside.
Earnings projections are $1.03 per share on $21.69 billion in revenue. I just think the Fed's new posturing will make this a good quarter for the bank.
The Fed is expecting to bring sb. up interest rates this year which is a signal of underlying strength in the US economy. However if this was not to come to pass and if the US entered another steep recession, bank stocks would come under more pressure than other sectors. This scenario is definitely a possibility but presently we don't seem to be anywhere near a scenario such as this. Nevertheless, position sizing and diversification are extremely important which help negate any unforeseen possibilities.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)I wrote this article myself, and Obie expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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