Owning bank stocks is a great way to hedge against inflation, as this industry tends to thrive during inflationary periods. But there's one banking stock that may be a better bet than others. On a Fool Live episode recorded on June 17, Fool contributor Matthew Frankel talks about why his favorite bank stock right now is Wells Fargo (WFC -0.03%).
Matt Frankel: It's really tough to find an industry that is more equipped to invest in during an inflationary environment than banks. At the beginning of 2021, all of us on Industry Focus, we do a different sector every day. We all set our favorite stocks for 2021 and mine was Wells Fargo. I got a lot of pushback in "OK boomer" comments on Twitter about it because everyone is expecting like a Square, a PayPal, or something more exciting.
But no, Wells Fargo. It's up about 50 percent year-to-date, so I would have to say "OK boomer" to all the people who doubted me at first. But anyway, looking forward, in an inflationary environment, there are still a few things from my original thesis that apply. One, the bank is still limited on how much it can grow. There's a Federal Reserve imposed asset cap due to all of its bad behavior in previous years. Its dividend still hasn't normalized, it had to slash its dividend last year at the beginning of the COVID crisis. It is prioritizing expense reduction, which really hasn't worked itself into the numbers yet. A few things still applied to my original investment thesis.
But in an inflationary time, banks tend to not only be resistant to inflation because they have pricing power with their loans and things like that; interest rates rise, banks can charge more on loans. But their margins tend to increase, so they tend to actually do better during inflationary times. Banking profits, in terms of consumer banking, are best measured by a metric called net interest margin. That's a difference between what banks are charging for loans and what they're paying on deposits after considering all expenses.
In the first quarter of 2021, Wells Fargo's net interest margin was 2.05 percent. That means [if] they loaned a billion dollars. They made a little over 2 percent of that. A year ago, it was 2.58 percent, so significantly higher. Remember, the first quarter of 2020 was mostly normal in terms of the business world. We didn't really see the COVID pandemic really hit till mid-March. In 2019, the first quarter, it was almost three percent. Right now, it's just over two percent. It was almost three percent two years ago. That's a 50 percent higher profit margin, in what I wouldn't even call an inflationary environment, but just a more normal environment. Now we're getting into inflationary times.
Wells Fargo is the way I would play inflation rather than any of the other banks because it's the most consumer and commercial banking focused. In other words, only eight percent of Wells Fargo's revenue comes from investment banking. When you look at the JPMorgan Chase's and Bank of America's, and Citigroup's, it could be about half. So very, very consumer and commercial focused bank. About 75 percent of its revenue comes from just savings and loan activities. Most of the rest is from wealth management. They have a big wealth management division for high net worth clients and things like that.
Now, some of the loan rates that Wells Fargo has, credit cards, in particular, are directly tied to federal funds rate increases, which we'll see in an inflationary environment. Some just tend to move in the same direction as inflation and interest rates. Wells Fargo is a giant mortgage lender. That should help tremendously in an inflationary environment. They have some auto loan and personal lending businesses as well. That net interest margin expansion, their net interest margins could double if inflation stays at four percent. That's a huge profit boost to an already very profitable business.
I think the banking sector is a great way to play inflation if you think that inflation is here to stay. Obviously, none of us have a crystal ball that will tell us what inflation will do. If you were to ask the three of us what the inflation rate is going to be in 2022, you're probably going to get three different answers and all of three of them will probably be wrong.
So none of us knows what inflation is going to do, but if you're worried about inflation, you want to maybe hedge against some of the more growthier names in your portfolio. Banking is a really good way to do it because not only does banking survive during inflationary periods, but a lot of times their earnings actually increase during inflationary periods. That's Wells Fargo.
