This Cheap Stock Just Gave Investors a 14% Raise. Here’s Why You Should Take a Look.

Wells Fargo (WFC 2.03%) recently reported its second-quarter earnings, and thanks to disappointing net interest income, the stock plunged by as much as 7% shortly after the announcement. That’s a big move for a large-cap bank stock.

While the interest income miss was definitely disappointing, it’s important for investors to realize that this is a rock-solid financial institution that has done a great job of turning itself around in recent years, and that interest-rate headwinds are temporary. There’s a lot about Wells Fargo long-term investors might like, and here’s why I think it deserves a closer look, especially at a newly discounted share price.

Wells Fargo’s disappointing second quarter

Wells Fargo actually beat expectations on both the top and bottom lines in the second quarter, but the problem is that the bank’s net interest income declined significantly more than expected. Wells reported $11.92 billion in net interest income, a 9% year-on-year decline, and about $200 million less than analysts had been expecting.

The short explanation is that while interest rates have risen in recent years, the bank’s cost of funding — deposits, borrowing, and so on — has increased at a faster rate than the yields from its loan portfolio. Plus, the loan portfolio itself has contracted by about 3% over the past year, especially because of weak mortgage and auto loan demand. For example, mortgage originations fell from an already weak $7.7 billion in the second quarter of 2023 to $5.3 billion.

The quarter wasn’t all bad. Fee-based revenue has grown, specifically when it comes to investment advisory fees, trading revenue, and investment banking fees. Noninterest expense actually declined 2% sequentially. And the bank’s net charge-off rate remains well covered by its reserves. But the sharp decline in net interest income seems to be scaring investors a bit.

Reasons to be optimistic

There’s a lot to like about Wells Fargo from a long-term perspective. For starters, the interest-rate headwind is a temporary one. Rising rates have put pressure on margins, but if rates normalize over the next few years as expected, it could go the other way. And as the most consumer-focused of the U.S. megabanks, Wells Fargo arguably has the most to gain when rates fall.

The bank has also done a great job of prioritizing capital return to shareholders, both in the form of dividends and buybacks. As mentioned in the introduction, Wells just increased its dividend by 14% and now yields 2.5%. And when it comes to buybacks, Wells Fargo spent $12 billion on buybacks — roughly 6% of its entire market cap — in the first half of 2024 alone.

Finally, the Federal Reserve’s asset cap that essentially prevents Wells Fargo from growing has been in place for years, but there’s reason to believe it could be lifted within the next couple of years. The bank traded for an average of about 1.6 times book value before it was implemented, and its multiple is currently less than 1.3.

The bottom line is that Wells Fargo already looked like an attractive long-term investment opportunity before earnings, and it looks even better now. To be sure, depending on what happens with interest rates and the economy in general, it could be volatile for some time. But this looks like a great entry point for patient investors who measure their returns in years.