January 12, 2013 Comments

My popular article on the valuation of the Dow Jones Industrial Average is updated. I see the Dow as about fairly valued.

On Friday we had Constellation Software up 3.7%.

I no longer have Research in Motion on the list, but it was up 13%, again indicating that rumors of its death may have been premature.

Wells Fargo came out with excellent earnings although just a hair above expectations) and dropped 0.9%. Apparently bank analysts were disappointed that its net interest margin fell to 3.56% from 3.66% last quarter. So let’s examine that. The average 30-year mortgage rate in the U.S. is 3.4%.

Now, if Wells pays nothing on deposits it still can’t make 3.56% on a mortgage sold at 3.4%. Wells Fargo has about the highest net interest margin in the business. Part of the reason its margin fell is that it took in a lot of new deposits on which it is paying nothing or next to nothing (that’s the good news for the bank) but it has parked those deposits at the Fed earning 0.25% because it can’t find suitable people and businesses to lend all that money to (that’s the bad news, but keeping cash on hand is better than lending it to those who can’t pay it back).

And remember Wells is not making this 3.56% on its own equity. It is making a gross margin of 3.56% on lending out depositors money. It’s own ROE is MUCH higher due to leverage.

I am no expert on bank finances, but I do know a little bit. And I think these analysts get too focused on particular ratios. In this case it is net interest margin. In other cases it is same store sales for retailers. I may be naive but when I see a 25% increase in profits like Wells has posted here, I tend to think that is pretty good. I am a happy Wells Fargo owner.