A Bank Stock That’s Cheap and Solid

11/14/2007 12:00 am EST

Focus: STOCKS

John Dessauer

President, John Dessauer Investments, Inc.

John Dessauer, editor of John Dessauer’s Investor’s World, says Wachovia is a strong, diversified bank that should benefit when the housing market stabilizes.

Banks are financial intermediaries. They match up those with excess capital with others who need capital. They do this in many different ways and on a global scale. We own some of the best banks in the world—those that will emerge from this liquidity crisis to deliver superior profits.

Wachovia (NYSE: WB) took a $1.3-billion write-down for bad loans in the third quarter. That pushed operating profits down to 90 cents a share from $1.04 a year ago.

Banking is directly connected to the underlying economy and the customers that the banks serve. Obviously, the mortgage market disruption and housing slump are taking a toll. But this is temporary. Charlotte, NC-based Wachovia is highly diversified and well-positioned to resume growth when housing stabilizes. The stock will move sharply higher at the first sign of improvement in the mortgage market.

Earnings estimates for 2008 are running around $5.40 a share, making Wachovia one of the cheapest big-cap banks, trading at [slightly more than eight] times projected earnings. (The stock closed Tuesday under $44—Editor.) The current dividend rate is $2.24, for a yield of 5%.

The stock was trading near $59 earlier this year, before the announcement of the Golden West acquisition. Golden West Financial is the parent company of World Savings Bank, an outstanding mortgage-lending bank with a 40-year record of double-digit earnings growth and high credit standards.

Wall Street analysts pounced on the news, saying the price and timing were wrong. They argued that Wachovia was buying into the mortgage business at a cyclical peak and would pay a heavy price when the cycle reversed.

Under the leadership of chief executive officer Ken Thompson, Wachovia is now a diversified major financial services player. What Wachovia lacked was a substantial mortgage lending business. The Golden West acquisition filled that need. It also opened up significant cross-selling opportunities in the World Bank branches.

There will be increased mortgage delinquencies at World Bank. That cannot be avoided, even with excellent credit standards. Wachovia has also completed the acquisition of A.G. Edwards, the St. Louis-based national brokerage firm. This expands Wachovia’s private banking business.

Wachovia has earnings potential far above Wall Street’s current view. Over the next 12 months, I expect estimates for 2009 should be above $6.00 a share. The long-run historical P/E is 12x, pointing to a stock price of $70 by the end of next year. Wachovia is a Buy.

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