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Wells Fargo is pretty likely to hike its dividend in 2013

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January 14, 2013 – Comments (0) | RELATED TICKERS: WFC

This is the understatement of the century: The big banks and financial firms have been through a lot in the past four years. Their investors have also been through a lot.

However, the general economy has gradually begun to recover. More people have jobs. This means that they have money. This, in turn, means that they are more likely to get mortgages or other consumer loans, and that they are less likely to default on the loans they have.

Consumer credit is, fortunately, Wells Fargo's bread and butter. So the improving economy is good for Wells Fargo. Its capital ratios are steadily improving. The bank was one of the first large banks to raise its dividend, as regulators gave it the leeway to do so. Wells stands out from the larger banks because it is managed by people who understand that retail banking is simple and unlikely to blow up in anyone's face, and because its cost of funds is lower than all its peers - therefore it is more profitable at retail banking than its peers.

JP Morgan chase is also a very well-run big bank.  However, in contrast to Wells, JP Morgan is complex and has a big investment banking operation. Last year JP Morgan lost several billion dollars on a hedge against high-yield corporate bond defaults. Wait, you ask, they lost several billion dollars on a hedge, which is supposed to protect you against losses? That's exactly the problem. Their hedge essentially turned into a proprietary trade without higher management noticing. That won't happen at Wells.

At this point, I think Wells' stock is definitely worthy of consideration. The stock price remained flat-ish in 2012 despite the bank's gradually improving capital ratios. Management is targeting a 50 to 65 percent payout ratio in the long run, and their capital position should give regulators confidence that this payout is acceptable. Right now, Wells' payout ratio is in the 20s. I expect a dividend raise in 2013.

In addition, investors can consider the Wells Fargo TARP warrants. These expire in 2018 and have a strike price of $34. The strike price is reduced for all dividends above $0.34. The current quarterly dividend is $0.22, and I expect Wells to breach this level by next year. With the warrants trading at $10.60 right now, Wells has to trade at $45 or (probably a bit less given dividend adjustments) by 2018 for you to break even. That's five years away. The market is pretty likely to have woken up to Wells by then.

I'm long the warrants but not the stock. I think that right now, the warrants are the better buy.

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