Time to Buy? Financials are Doing the Talking

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The markets are picking up steam, recovering from the 7.5% peak-to-trough fall. Cyclical sectors have taken the lead from the June 24th low. While Materials and Utilities are offering opportunity for value buyers with their under-performance against the broader market, it has been Financials and Consumer Discretionary which have been leading from the front.

Last week's improved employment figures and rise in consumer sentiment is good news for consumer confidence and spending. Rising interest rates from an expanding economy allows banks more leeway on the borrow-lending spread, which is ultimately responsible for generating their profits.

The Financial Select Sector SPDR (NYSEMKT: XLF) has returned nearly 7% (at time of writing) since its swing low, and is one of the first sectors to make new highs for 2013. This particular fund has enjoyed strong cash inflows over the past week attracting $805 million in investment.

Banks have benefited from a steady decline in nonperforming loans, which offers earnings stability. Plus, there has been a corresponding rise in Banks' Total Assets value. The worst effects of the financial crisis appear to be behind them.

<img alt="" src="http://media.ycharts.com/charts/be46100c920b6a30af5b8c9c04882397.png" />

US Nonperforming Total Loans for all Banks data by YCharts

Digging down to individual names, revenues from the two lead components of the ETF, JPMorgan Chase & Co., and Wells Fargo & Company have also started to recover following their respective acquisitions of Bear Stearns and Wachovia during the credit crisis. Periods of flat revenues in the past have been followed by sharp advances as recession gives way to expansion.  A slowly improving job markets, improving yields and signs of a more aggressive Fed signify a macro turn in the economy. 

<img alt="" src="http://media.ycharts.com/charts/ba848c2d9bbf971219943bdb28ad535b.png" />

JPM Revenue TTM data by YCharts

In January, I suggested three financial stocks for the first half of 2013: Ameriprise Financial Inc. (NYSE: AMP), American Express Company (NYSE: AXP), and Invesco. All three have outperformed the S&P for this period, but best of the three is Ameriprise Financial which is up 30% from its feature price over the course of the half year.

Ameriprise Financial

Ameriprise Financial looks set to continue its good form. The stock had started the year on a strong footing, trading above its 2011 and 2007 stock highs and becoming one of the first financial stocks to do so. It has retained the interest of income investors by steadily raising its dividend payment as its stock price has risen: shifting gears from a quarterly payment of $0.18 in 2011 to $0.52 in the most recent quarter.

This has been assisted with an aggressive stock buyback, which has enabled existing shareholders take home a greater share of the dividend pie. The net effect has been to keep yields around the 2.5% mark, but it has also fueled capital growth on dividend reinvestment. The company remains focused on returning capital to shareholders in a "prudent manner". The plan for this year is to return 100% of earnings to shareholders, plus the $375 million freed up from exiting the bank.

The company's most recent quarter came in just ahead of earnings-per-share expectations, with a respectable beat on revenues. Its Wealth Management business remained the core business driver and generated "very strong results". Europe remained a drag, although the improvement in global equity markets helped offset weakness in low yielding bonds. Operating revenues increased 7% to $1 billion on record retail client net inflows and market appreciation. Advisor client assets grew 11% to $372 billion with net inflows of $4.1 billion, a 41% gain year-on-year. Advisor productivity was also up 9% as measured by net revenue per advisor. Quarterly growth was delivered from its retail division, less from its assets under management which was up 2% sequentially to $466 million. If there was a caveat to the retail division results it was that cash positions were "abnormally high", particularly at end of year (Q4 heading into Q1). This means less trading and therefore less revenue, but it's also money available to go to work.

The company is still bedding in its new brokerage platform: it's looking at a 18-24 month period to get its advisors up to speed. I don't expect cost efficiencies to show until then. Comments made on the call were defensive with regards to its costs, but as with many significant technology upgrades it will take time to deliver results.

The company is looking at possible acquisition opportunities, but has yet to identify a suitable candidate.

American Express

American Express has enjoyed great success since coming back from its 2009 low. The improvement in consumer confidence has helped drive this stock forward. It has also been helped by its older, richer demographic who through their spending have delivered gains not only for American Express, but also for the recipients of their spending like luxury discretionary brands LVMH Moet Hennessy Louis Vuitton, Michael Kors, and Tiffany and Co. It also helps that Warren Buffett has held this stock since 1991, and owns a 13.8% stake in the company through Berkshire Hathaway; this has made the stock attractive to followers of Buffett.

For year-end, the company generated 5% revenue growth and 8% growth in Earnigns Per Share (EPS) to $4.40. There was an average spend per "basic proprietary card members" of $16,000 for a total of $880 billion on the year - a record for the company. Bank of America saw a 7% year-on-year quarterly rise in average retail spend per its credit card customers, but didn't offer an overall spend value. While Visa similarly noted a 6% growth in processed transactions. However, American Express noted "Citi, Chase, and BofA continued to see an absolute decline in balances for the fourth year in a row", an area where American Express was able to generate growth. This helped the company obtain a 15.6% share of the credit market as the debit card market 'slowed'. While its competitors fight across a relatively narrow (and stressed) demographic, American Express appears able to pick up the high-end and newly minted customers with relative ease.

The company has continued to fulfill customer expectations, delivering a 40% gain over the last five years in customer retention and has seen improvement in 'recommend a friend' metrics.

As with Ameriprise Financial, the company is engaged in a share buyback program, repurchasing up to $4.2 billion shares in 2012, with a dividend increase to $0.23 for the most recent quarter. The dividend yield stands at 1.2% (at writing), which is about that half of Ameriprise Financial, but better than Visa or Mastercard Incorporated.

On the downside, there was the slap on the wrist as relates to customer disclosures for a number of issues , including debt collection and fee charges. These are key revenue sources for the company and damages not just the company's bottom line but also its reputation as a premium consumer service provider. Consumers are willing to pay to be a part of the American Express brand, but if the company was to cock up again it would then be a case of 'fool me twice, shame on me'.

Summary

Financials have enjoyed a great run over the first half of the year and it doesn't look like the sector is losing any of its steam. Certainly, the strong equity market as helped Wealth Management companies like Ameriprise Financial. While improving consumer confidence has helped discretionary companies and payment providers.

The underlying recovery has been modest, but this has helped deliver capital returns in small steps. A longer, more sustainable recovery is better suited to the aforementioned equities than the 'V' style snap-back recovery many had originally hoped for.

Certainly, there is good reason for optimism going forward. 


Declan Fallon has no position in any stocks mentioned. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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