Dow 20,000: Banks Stocks Still Offer Value

After a couple of hesitations, the Dow yesterday sailed through the psychologically important 20k mark. Anticipation of lower corporate tax rates and reduced regulations helped bring the rally close to that level, but the final push came as several key components to the Dow reported good earnings.

Even in an environment of optimism, fundamentals still matter and looking forward, it is the areas that can still improve in that regard that offer the best prospects from here. On that basis the two main financial stocks in the index, JP Morgan Chase (JPM) and Goldman Sachs (GS) are the places to be right now.

After nearly a decade or so of lagging behind other sectors, the big banks are finally playing catch up and with what looks like a perfect storm coming for them, they will have even further to go. A rising interest rate environment will definitely help, as will the rolling back of some of the Dodd-Frank regulations that both Congress and the new President seem determined to pursue.

Perhaps the biggest plus for JPM and GS is the very fact that the Dow has broken the 20k level.

Both banks have a large presence in capital markets, and their investment arms now rely largely on fees based on the value of accounts. Obviously, with stocks at record highs, their fee income will be following suit. Trading income should also continue to benefit as we see heavy interest in both stocks and bonds; indeed we have recently broken the record for fixed income trading volume a couple of times.

That would all suggest that the big beats of earnings expectations that we saw in Q4 of last year can easily be repeated if not exceeded in the first quarter of this.

Usually, when we get to record levels in stock prices, valuations become a concern. In the case of the big banks, however, despite the recent run up, that really isn’t an issue. JPM is currently trading at around eleven and a half times the next twelve months forecast earnings and GS is even cheaper, at closer to eleven times.

Other fundamental metrics also point to value still being in these stocks as well. For example, the capitalization of both represents around one and a third of their book value. By way of comparison the broader based S&P 500 has a price to book ratio of nearly three and a forward P/E of nearly seventeen and a half.

That implies that even if current profit expectations are simply met rather than exceeded, both stocks could jump by around fifty percent, just to bring them to the average. Of course, it is not that simple as financial sector stocks do typically trade at below average multiples of earnings, but even so when all of the factors conducive to growth are included there has to be significant upside to both JPM and GS from here, even with the overall markets at these giddy, somewhat scary looking heights.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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