Buy Offshore Banks for Faster Growth and Bigger Gains

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

With the U.S. economy projected to grow only an anemic 1.9% this year, many developing countries are becoming more dependent on their own quickly growing middle classes to drive economic growth and demand for domestic goods and services.The banking industry almost always benefits greatly from growing economies like these, and investors seeking current income and exceptional growth potential need look no further than our neighbors to the south. Here's why you should buy the best banks doing business in South America's expanding economies.

Where to look and what we want to see

When looking at banks in developing countries, investors should first seek stocks traded on one of the U.S. exchanges. Even though this does not guarantee anything in particular, it does tend to provide some degree of liquidity, and at least a bit of regulatory oversight and reporting requirements.

Stocks with a current P/E multiple less than the 5-year projected growth plus the dividend yield tend to deserve extra attention, since this metric tends to indicate they're undervalued. The cumulative effect of this criteria provides a solid base from which to  begin a detailed due diligence process.

A quick screen set for international banks traded on U.S. exchanges produced a list of initial candidates, which was easily reduced to those with a South American focus.

A multinational with broad exposure

Banco Bilboa Vizcaya Argentaria (NYSE: BBVA) is based in Spain and offers banking, pension and insurance products in Spain, Portugal, Mexico, and South America, while also offering standard banking services in the U.S. and Puerto Rico. The 6.07% dividend yield is a real eye-opener and the current market valuation of only 0.82 times book value causes this stock to warrant a closer look.

Unfortunately, over the past five years, the net income has fallen at an annual pace of 23.93% as a result of the debt crisis that has engulfed the weaker members of the European Union and its exposure to the weak economies of Spain and Portugal. After consideration is given to the 80% payout ratio required to cover the current dividend, the negatives begin to outweigh the positives in the evaluation of this stock as an investment opportunity.

A smaller, more focused opportunity

My initial screening also produced a smaller bank operating in a developing country with a projected growth rate of 4.5% for this year -- fully 137% higher than the United States's pace. The fast-growing country is Colombia, and the bank that will benefit from the growth is Bancolombia (NYSE: CIB).

While many people think of drugs when the topic of Colombia arises, they are actually large exporters of coffee, plantains, almost the entire U.S. supply of roses, and most of the world’s emeralds. Nickel and copper are its fastest growing exports. Quite simply, there are many more opportunities in Colombia than most people realize, and the country's profitable banking investment (along with the emeralds) is one of its undiscovered gems.

Bancolombia has a current dividend yield of 2.82% that requires a payout ratio of only 37% to support. This current ratio allows ample room for increases even if profits remain flat; an unlikely scenario given the projected economic growth rates for the country. Over the past five years, this bank has increased its dividend at an annual pace of 8.06%, firmly establishing management’s commitment to rewarding shareholders.

With a projected earnings growth rate of 9.3% per year for the next five years, this bank should reward investors with a total annual return of around 12% per year between dividends, and a share price that rises along with the earnings growth.

Ultra-fast future growth at a bargain price

With primary exports consisting of transport equipment, soybeans, coffee, iron ore, and footwear, Brazil helps feed the world and provides base materials for steel manufacturing. At 2.9% growth, the economy of Brazil is projected to expand a full 50% faster than that of the U.S. this year. But you would never know it from the market valuation assessed to Banco Santander Brasil (NYSE: BSBR).

With a projected annualized increase in earnings of 22.7% per year for the next 5 years, Banco Santander is priced at a measly 9.41 times 2013 projected earnings and carries a price to book ratio of only 0.71. Rosy predictions are easy to make, but considering that this bank has grown its net income at an annual pace of 23.34% over the past five years, the forward projection would appear to be achievable.

The extremely generous dividend yield of 4.89% does require a troubling 95% payout ratio to support, but it's probably sustainable, considering the exceptional earnings growth projections for the business. If the share price were to simply rise along with the earnings growth rate, investors would be rewarded with astounding capital gains from this investment. And if the stock were to simply rise to a price equal to the book value, a 40% gain would result.

Final thoughts and immediate actions

Banco Bilbao operates in some truly attractive markets, but it's also present in some that would appear to increase the risk exposure and limit potential overall growth.

Bancolombia is doing business in a growth country that is experiencing improving economic and social stability with some very sustainable industries. This is a business that deserves very serious consideration as an opportunity to add some safe, international exposure to a well-balanced portfolio.

Banco Santander is quite simply one of the most compelling opportunities offered in the market today. Investors who fail to act now in taking a position in this stock may well regret that lack of action for many years to come.

Ken McGaha has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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