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By Pat Dorsey, CFA | 08-20-2010 10:26 AM

Dorsey: Two Simple Reasons to Own Wells Fargo

Two advantages and a compelling valuation make this bank worth holding, says Morningstar's director of equity research.

Pat Dorsey: Hi. I am Pat Dorsey, director of equity research at Morningstar. I've been addressing some big picture topics in the videos recently: profit margins across the economy, trends for the broader economy coming out of earnings season. So I thought it will be a little bit fun to change things up this week and just talk about a stock that I happen to like and that I happen to own, Wells Fargo. And there's two reasons I like Wells Fargo, and I own Wells Fargo, and they are pretty simple: cheap deposits and cross selling.

First of all, Wells Fargo is able to basically source money cheaper than just about any another large bank in the United States. Their cost of funds in the second quarter was about 77 basis points, which they then turned around and lent out at about 5.1%. So basically, their cost of funds was under 1%, it turned around and lent that out of 5%--and that's pretty good.

For comparison, Bank of America's cost of funds was about 1.3%, much higher than Wells Fargo's 0.77%, and they were only able to lend it out at 4%, so that's a much smaller, what we call, net interest margin or spread on the difference between what the bank sources of funds at and what it is able to loan the money out at, because that is essentially how bank makes money. They take it in from one area, pay a little bit of interest rate for it and then lend it out at a higher rate.

So cheap deposits are sort of the number-one reason why I like Wells Fargo, because at the end of day, banking is unfortunately a commodity business, and in a commodity business, it is the low cost producer that wins, and in many ways, Wells Fargo is a low cost producer in banking, certainly among the largest banks.

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