Sunday, November 14, 2010

Wells Fargo - Profits, Do They Matter?

Just a quick follow up from my previous post regarding profits. I was told that I didn't understand profits. In response I offered a simple formula to person who made the comment. It was,

Revenue - Costs = Profit.

Now some companies understand that formula and some don't. Some companies can control the revenues, while others cannot.  I believe all companies can control the cost part of the equation.

The best management of any business strive to minimize costs and maximize profits.

If I could quote from the 2008 Wells Fargo annual report to shareholders.

Our revenue grew 6 percent, and our expenses declined one percent — the best such revenue/expense ratio among our large peers, and the one we consider the best long-term
measure of a company’s efficiency.

• Our return on equity (after-tax profit for every shareholder dollar) was 4.79 cents for every dollar of our shareholders’ equity, best among our large peers.

Now those are wonderful words to read from any CEO in which you own shares.  Maximizing revenue while lowering costs, it all adds to higher real returns for the shareholder.

Don't let anyone tell you investing is difficult, like some who have commented here make it out to be. They liken investing to panning for gold, or a search for buried treasure. It has far more with understanding your assumptions, focusing on real returns, and a consistent operating history. I'm not saying there isn't value in the panning for gold technique but you have to understand your assumptions, accounting, and risks involved.

Futhermore, degree of difficulty doesn't matter in investing. Temperment does. Investing within your circle of competence does. I find it amazing that many value investors don't understand what Buffett means by the circle of competence comment. Personally, I take it to mean more than avoiding technology stocks, but understanding and minimizing your variable/assumptions.

Finally I leave you with a quote from Wells Fargo's 2009 annual report. I highly recommend reading the letter to shareholdes for the last few years if you haven't read them already.

Where does the bank stop and the community begin?

How have we been able to grow earnings and capital internally, and become even stronger, even while building a storehouse for credit losses of almost $25 billion? It’s because our business model doesn’t run on just a few sources of revenue or even 20 or 30 sources of revenue, but on more than 80 different businesses across financial services. It’s because our loan portfolio is diversified across many different industries. It’s because we’re not geographically concentrated in one region, but serve
70 million customers across North America. It’s because of our time-tested credit discipline. It’s because we have the deepest, most talented, most experienced and people-focused team of senior leaders in the industry. It’s because we believe our longterm success depends on our ability to help our customers and communities succeed financially.

And often overlooked, it’s because all banks are not created alike. We’re not a hedge fund disguised as a bank. We’re not a proprietary trader (which produces no customer benefit) disguised as a bank. Nor are we simply a mortgage company or an investment broker or an insurance broker or a credit card company. What we are at our heart is community-based, and relationship-oriented. We serve our customers online, on the phone or at our ATMs, and we welcome them into our 10,000 stores. We greet them on neighborhood sidewalks. We have breakfast with them at the neighborhood diner. We serve alongside them on local chambers, Rotary, nonprofit boards, at community events. We worship with them in churches, synagogues, mosques and temples. Many of our customers know our tellers by their first names, and we know them by theirs. We want our banking stores to be more than just storefronts, but like community centers where neighbors meet.  Call this old-fashioned if you like, but our customers can’t get enough of it. They wouldn’t trade it for all the hedge funds in the world. I could tell you a thousand real-life stories to prove this point. You can read about just a few beginning on page 24 of this Report and in our new Social Responsibility Report.

Management who understand and focus on customer service are the ones who will reap the largest returns.  Meet the needs of your customer in any business and your reputation & profits will follow.

Well if you can't already tell, I absolutely love Wells Fargo.  I plan on owning my shares for several decades.  The recent credit crisis has afforded an opportunity to purchase shares of Wells Fargo at very reasonable levels to book value.  The company can and will earn large profits, around 18% on equity, long, long after ATPG goes broke trying. 

Best Regards,

Disclosure:  I own shares in WFC

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