For many decades, it was pretty easy to analyze bank stocks. You
simply needed look at their balance sheets and where we stood in
the economic cycle. In tougher economic times, banks stocks
typically traded right down to tangible
book value
, as that was the price in which a bank could simply be liquidated
or sold for its assets. In better economic times, banks were
typically valued closer to 1.5 times book value, under the notion
that a bank's assets could help generate impressive returns on
investments.
Yet when long-standing restrictions against entering a wide range
of banking services, from investment banking to retail branch
operations, came down about 15 years ago as a result of the repeal
of the Glass-Steagal Act, the industry really caught fire with
investors. Faced with more robust growth prospects, many bank
stocks started to drift up to two times book value, which became
the new price point at which many banking deals occurred.
The recent financial crisis has changed all of that. A number of
bank stocks have been so beaten down that they can trade below
tangible book value. As this table shows, that's the case with some
of the nation's largest banks. All of these mid and large cap banks
continue to trade below book value.
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There are two takeaways from these current low valuations. First,
all of these bank stocks should benefit from an improvingeconomy ,
which willyield an expansion in their price-to-book (P/B) ratios,
perhaps up to 1.25 or 1.5 times book value. Second, the book values
themselves should continue to grow higher, as has been the case in
recent quarters,
asset
write-downs notwithstanding. The need for further write-downs now
looks less necessary, as most of the bad loans have been purged
from balance sheets. Taken together, these two factors could propel
some of these bank stocks up 50% to 75% in the next few years.
I continue to think the
turnaround
at Citigroup has yet to sink in with investors, as
I noted here
.
As I said back in December, the bank is repositioning itself as a
key player in fast-growing emerging economies. Indeed, Citigroup
now derives more than half its revenue from abroad. Although the
bank's turnaround is not yet complete, the story should become a
lot cleaner with each passing quarter, and eventually, investors
should embrace the bank as a way to
hedge
against a falling dollar and as a way to have greater exposure to
more dynamic economies elsewhere.
The small fry
In a similar vein, smaller banks that are trading well below book
should hold great appeal. Either the price-to-book gap will close,
boosting share prices, or they'll get acquired for their assets.
The banking industry has been consolidating for two decades. That
process was interrupted during the financial crisis, but it
shouldkick back in as the industry and the
economy
stabilize further.
Here's a look at some of the most severely undervalued bank stocks
on a price-to-book basis.
(Same as above)
Guggenheim Securities has been tracking the industry's mergers and
acquisitions activity and suggests banks situated in economically
robust regions, or those that have strong brand resonance in local
communities, are likely
acquisition
targets. Their analysts suggest
Regions Financial (
RF
)
,
First Horizon (
FHN
)
and
Synovus Financial (
SNV
)
represent potentially large deals, while
Associated Banc-Corp (Nasdaq: ASBC)
,
Bancorp Rhode Island (Nasdaq: BARI),
and
Pinnacle Financial Partners (Nasdaq: PNFP)
are smaller fries that could be snapped up at a nice premium.
Action to Take -->
All of the smaller banks in the table above are expected to report
first quarter results in a matter of days. If operations appear to
be healthy and book value remains well below share prices,
then it may be time to pounce, as investors could eventually see
outsized gains from these stocks.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.