Buy the Financials Still Trading Below Book Value - Part 2

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Even after substantial gains this year, a number of financial stocks still trade below book value. While not covered back in January along with the insurers and airplane leasing firms, a cross section of other financial stocks continue to trade considerably below book value. While the fears from the financial crisis have mostly dissipated, the stocks continue to meander below book value even with strong earnings profiles.

Stocks ranging from business development corporations (BDCs) to regional banks in some cases still trade below book value.

While book values aren’t perfect, in most cases the books are even cleaner now than prior to the financial crisis, when most financial stocks traded at multiples of book value. The stocks, though, face fears of a rapidly rising interest rate environment. Combine that scenario with limited dividends and investors have been unwilling to pay for the value of the assets on the books.

Two cheap BDCs

While not typically focused on as part of the financial sector, these BDCs invest in either middle market or venture backed firms. Either way, American Capital (NASDAQ: ACAS) and GSV Capital continue to trade significantly below book value. Back in January, the stocks traded at similar valuations at levels close to 0.7 times book value. With current prices not significantly different than at the start of the year, the stocks have failed to participate in most of the rally this year even considering the valuation proposition.

In the case of American Capital, the company continues to repurchase shares at a significant clip each quarter. In a yield-starved market, most investors aren’t excited by this move to forego dividends even if it has helped juice the book value.

GSV Capital, on the other hand, invests in pre-IPO stocks to take advantage of a market that encourages companies to delay the IPO process. GSV famously failed to profit from bets on Facebook, Groupon, and Zynga, but the current largest position in Twitter has the potential to be a home run now that it has matured. In essence, a new investor in GSV Capital is able to obtain these venture stocks at nearly 60% of actual market value.

A couple of regional banks

While the regional banks making this list are far from grossly undervalued, both Regions Financial (NYSE: RF) and SunTrust Banks (NYSE: STI) continue to trade below book value, all while both stocks have reported strong earnings. As with most financials, these regional banks traded at book value multiples of 1.5 times in the years prior to the financial crisis. With the economy on the mend and real estate recovering, nothing in the current climate justifies a book value below 1. Both stocks could easily gain 20% in order to be inline with the current book value of both stocks.

10-Year book value chart

As the below chart highlights, the book value was typically closer to 1.5-2 times prior to the financial crisis. The typical stock in this group would need to almost double in order to reach that pre-crisis normalcy.

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ACAS Price / Book Value data by YCharts

Earnings potential to grow book value

As with the insurance and airplane leasing stocks listed in parts 1 and 2, the interesting dichotomy in this group of financial stocks is that the earnings potential remains strong. All of the stocks, except GSV Capital, have solid earnings generation potential. The question is, how a stock can trade below book value that generates solid profits that will grow that value?

American Capital is expected to report flat earnings of $1.16 last year to the same amount next year. The stock trades at the forward multiple of 11.2 times those estimates. The company has taken advantage of the stock trading below book value by consistently buying back stock with those earnings. With the stock dropping to $13 recently, investors should expect the company to continue repurchasing stock at a steep discount.

GSV Capital is the unusual stock in the group in that it lacks earnings since it doesn’t have an operating company. Rather, this BDC hopes to capitalize on gains in the positions of investments held.

Regions Financial expects earnings to grow from $0.74 in 2012 to only $0.86 this year and 2014. On an earnings multiple basis, the stock trades at 10.4 times those forward estimates. The stock provides a minimal 1.30% dividend yield.

SunTrust Banks is expected to see earnings dip from $3.59 in 2012 to $2.92 in 2014. The stock trades at roughly 11 times those forward earnings estimates. The stock provides a minimal 1.20% dividend yield.

Bottom line

While this group of stocks was not covered back in January, the fact doesn’t change that BDCs and regional banks offer tremendous value when still trading below book value. None of these stocks provide much in the way of a yield for conservative investors, but the regional banks probably provide more stability for risk adverse investors. The BDCs offer more aggressive growth opportunities depending on whether an investor wants to bet on the success of Twitter via GSV Capital or middle market companies via American Capital.

With big finance firms still trading at deep discounts to their historic norms, investors everywhere are wondering if this is the new normal, or whether finance stocks are a screaming buy today. The answer depends on the company, so to help figure out whether Regions Financial is a buy today, I invite you to read our premium research report on the company today. Click here now for instant access!

Mark Holder and Stone Fox Capital Advisors, LLC own shares of American Capital, Ltd. and GSV Capital. 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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