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Mid-Cap Dividend Growth Stocks By Sector: Part 2A Regional Banks

By Chuck Carnevale :

Introduction

In part 1 of this series on fairly valued mid-cap investment opportunities, I primarily focused on non-dividend paying growth oriented mid-caps. In part 2 of this series, I turned my focus to finding fairly valued dividend paying mid-caps. However, as I was evaluating dividend paying mid-caps in the S&P 400 mid-cap index, it became clear to me that the differences between dividend paying mid-caps were more important than the similarities. Therefore, I have grouped the dividend paying mid-caps I found into 3 separate offerings focusing on sectors. In this, part 2A, I will be exclusively covering fairly valued mid-sized regional banks.

However, I feel it's important to note that although there are several regional banks in the S&P 400 mid-cap index, I only found four dividend paying regional banks of reasonable quality that I considered attractively valued at this time. There were others that appeared reasonably valued, but they were excluded primarily because they were apparently willing participants in the financial debacle that many believe led to the Great Recession of 2008. Nevertheless, two of the four research candidates I present below did suffer stress during the financial crisis; however, their post-crisis recoveries have been stronger than those I excluded.

4 Fairly Valued Regional Banks

The following portfolio review summarizes the four mid-cap dividend paying regional banks. The portfolio review lists them by ticker, name, credit rating, sector, exchange, P/E ratio, dividend yield and market cap.

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Note : S&P Capital IQ does not report debt to capital on banks. Therefore, ignore the debt to capital number shown in the F.A.S.T. FACTS boxes to the right of the graphs.

Since many readers may not be familiar with each of these small-cap selections, I offer the following overview of each of the 4 research candidates. Courtesy of S&P Capital IQ, I included a short business description on each. Additionally, I have provided earnings and price correlated historical F.A.S.T. Graphs on each with a calculated return forecast out to 2017 based on what I considered the most appropriate valuation reference line.

Note: I have moved the return calculation pop-up to the left corner of the graph so that it did not cover up important data listed in the F.A.S.T. FACTS.

F.A.S.T. Graphs Tutorial

In order for the reader to get the maximum benefit from the following presentation, I offer a short tutorial illustrating the various components presented in F.A.S.T. Graphs. To accomplish this, I will present each component of the graph separately as I rebuild an entire graph. I have chosen Cullen/Frost Bankers, Inc. as my tutorial example because it will be the first research candidate I will eventually present.

My first screenshot reflects a plotting of earnings per share. The green shaded area represents a mountain chart of the company's earnings over the time frame drawn. The orange valuation reference line contains two important aspects. The first aspect is a multiple of earnings (P/E ratio) that is listed in the orange-colored rectangle in the F.A.S.T. FACTS to the right of the graph. In this example, the orange line represents a P/E ratio of 15. In other words, any time the stock price touches the orange line anywhere on the graph in this example, it will be trading at a P/E ratio of 15.

The second aspect of the orange line is the slope which is equal to the earnings growth rate. In this example, the orange line is increasing at the earnings growth rate (the green rectangle in the F.A.S.T. FACTS) of 6.8%. Although there is some cyclicality with earnings in between, this growth rate is calculated as the annualized growth from the first year's earnings per share to the last year on the graph.

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With my second screenshot, I overlay monthly closing stock prices. This illustrates how stock prices move in conjunction with earnings over the long run. Moreover, periods of overvaluation (when price is above the orange line), fair valuation (when price is touching the orange line) and undervaluation (when price is below the orange line) is clearly revealed. Most importantly, since stock price tracks earnings, it is clear that the company's earnings achievement is what drives the capital appreciation component of total return.

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This next screenshot adds a second valuation reference line (the dark blue line) which is a calculated normal P/E ratio for thetime frame drawn. In this example, the normal P/E ratio line represents a multiple of 16.4. With both of these valuation reference lines on the graph, a clear perspective of a range of valuation is revealed for analysis.

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This next screenshot adds a plotting of the company's dividends per share prior to being paid out of earnings. The area below the light green line (it appears white to many people) represents the portion of earnings paid out to shareholders. Therefore, the company's dividend payout ratio [POR] is graphically presented for instant reference.

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This next screenshot presents a second dividend reference. The light green shaded area above the orange line indicates the same dividends seen above after they have been paid out to shareholders. This light green shaded area (dividends paid) represents the dividend income component of total return.

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The complete F.A.S.T. Graphs illustrates the earnings and price relationship, offers two valuation reference lines and graphically presents the company's dividend payout ratio and dividends after they are paid out to shareholders. Most importantly, a perspective of the company's current valuation relative to fundamentals is clearly illustrated.

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Cullen/Frost Bankers, Inc. ( CFR )

Investment Thesis

I chose to present Cullen/Frost Bankers, Inc. for a couple of important reasons. First and foremost, I was attracted to the consistent historical earnings growth and steadily rising dividend. Although earnings weakened during the Great Recession, this regional bank performed extremely well on an operating basis in comparison to most of its peers. In other words, this regional bank avoided participating in most of the toxic behavior seen with most banks big and large.

I was also attracted to the company's high current yield and its current low valuation. Consequently, I see the combination of future P/E ratio expansion coupled with earnings and dividend growth in the range of 5% to 6% a compelling opportunity, as depicted in the performance calculation. Additionally, Cullen/Frost Bankers, Inc.'s A- credit rating is also a plus.

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Cathay General Bancorp ( CATY )

Investment Thesis

I included Cathay General Bancorp primarily because of its strong recovery since the Great Recession. Clearly, this regional bank did get caught up in the financial crisis. However, their subsequent recovery has been stronger than most of their peers. Hopefully, this regional bank learned a valuable lesson from the financial crisis. Current valuation is attractive, and I like the dividend yield in conjunction with an increasing payout ratio.

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East West Bancorp, Inc. ( EWBC )

Investment Thesis

I also included East West Bancorp, Inc. primarily because of its strong recovery since the Great Recession. Clearly, this regional bank did get caught up in the financial crisis. However, their subsequent recovery has been stronger than most of their peers. Hopefully, this regional bank also learned a valuable lesson from the financial crisis. Current valuation is compelling, and I also like the dividend yield in conjunction with an increasing payout ratio. Above-average forecast earnings growth coupled with the potential for P/E ratio expansion could lead to substantial total returns.

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Bank of the Ozarks ( OZRK )

Investment Thesis

I offer Bank of the Ozarks as a growth story with a dividend kicker. Although I consider this regional bank fairly valued to even fully valued, I like the company's historical operating record and growth potential going forward. Although the dividend yield is modest at approximately 1.5%, its record of dividend growth has been significantly above-average. Therefore, I offer Bank of the Ozarks as primarily a total return opportunity with modest current dividend income.

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Summary and Conclusions

The four mid-cap dividend growth stock research candidates featured in this article illustrate the differences that exist between individual companies. Two of these candidates represented examples of regional banks that avoided the worst of the financial crisis. Interestingly, one of them offered the highest yield with moderate growth, while the other had the lowest current yield with the highest growth potential. This speaks to the importance of selecting stocks that meet the individual investor's unique and specific goals and objectives.

The other two companies were exposed to the ravages of the financial crisis and their operating results suffered consistent with most huge money center banks. However, they were included because their recoveries were swift and strong and hopefully because they learned their lessons. Nevertheless, the reader should be aware of what happened to these two companies during the financial crisis.

Furthermore, investors most often associate small and mid-cap companies as growth stocks. However, just as it is with larger companies, there are many different types of mid-cap stocks that investors can utilize in their portfolios. In part 2B, I will present additional fairly valued mid-cap dividend growth stocks in the consumer discretionary sector.

Disclosure: No position.

Disclaimer:The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

See also Apple: On The Eve Of Earnings, A Little Good News on seekingalpha.com

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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