Reading Between the Lines at Wells Fargo

Financial services dominate the US Stock market. About 15% of the SP500 is made up by companies that operate in the financial world. The vast majority of these are financial institutions. Large players such as Citibank, JP Morgan and Wells Fargo dominate the market. With such market domination comes large revenues, massive balance sheets and thousands of employees. Big banks are complex in scale and scope, and many experts, let alone individual investors, are not completely sure what these companies do. When a company makes $22.5 billion in revenue in one quarter, just like Wells Fargo (WFC) did in the 3Q, from a wide range of services and products, it can be hard for retail investors to wrap their head around exactly what they are buying into. Wells Fargo has retail and commercial banking, mortgage products, trading and advisory services. Not exactly easy to wrap your head around. What matters for investors is if they can trust in the management teams of these companies to do what is in the customers, employees and shareholders long-term interest.

When Wells Fargo was slapped with a $185 million fine from the Consumer Financial Protection Bureau in September, investors should have seen this as a signal that Wells Fargo was not thinking about long-term best interests. For those not aware, the fine was handed down because of the more than two million accounts and credit cards that were opened for clients without their knowledge since 2011. The company promptly then fired the 5,300 employees who were associated with the scandal in hopes of controlling the fallout. The pressure on the company has remained and CEO John Stumpf has just recently stepped down from his role.

Outside of the obvious fallout from the scandal in fines, lost consumer trust and increased regulatory scrutiny, investors, or prospective investors, in Wells Fargo should take this announcement as clear indication to stay away. The scandal speaks volumes about the management team in place at WFC. Vuru followers will recall that a company’s management is one of the key drivers for determining the worth of an investment idea

The job of a company’s management team is to steer the company in the right direction, create returns for shareholders and put in place an organizational culture that gets the best from their employees. Wells Fargo let down their employees and shareholders through the system of controlling, incentivizing and monitoring throughout their organization. Management placed unreasonable sales and client acquisition goals for their retail banking staff and the only way employees could hope to meet these objectives was through the opening of fake accounts and giving clients credit cards they didn’t apply for. Employees felt felt they had no choice in order to get their bonus, keep their bosses happy and in some cases, keep their jobs. That is a sign of poor work on the part of management.

When it came time to own up to the poor job they had done, the CEO announced the firing of all employees related to the scandal. As much as these employees are responsible for their own actions, it is the responsibility of the company to put procedures in place for employees to feel comfortable about coming forward in the case that there are illegal activities going on. Wells Fargo failed to do this. The right thing to do at the time was for the company to acknowledge that their organization failed to put the proper procedures in place and failed to understand that the goals they put in place were unreasonable.

Good companies, and thus good investments create a culture and system in their companies that incentivize their employees to do the right thing, even if it may hurt the bottom line. This may hurt the company in short-term profitability, but the long-term relationships that they create with their employees and customers create long lasting sources of profitability. This is not the case with Wells Fargo, which according to Yahoo, had the number of chequing accounts opened in September drop by 25%. Wells Fargo’s 3Q earnings may have been better than expected, but look for the company to face trouble in the future. It will take a massive marketing campaign, freebies to current customers and extra incentives to new customers to bring them on with the company - all things that hurt the bottom line. As shown below, the company's earnings per share growth is already trending down.

When considering purchasing a company’s shares, investors should look beyond the numbers. How does management do business? Do they only care about profits, or do they do the right thing to keep their customers happy? Companies that do well in the long run understand that customer goodwill is much more powerful in the long run that extra profits in the short run.