Are These Investment Banks Suitable for Your Portfolio?

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After several years marked by losses and layoffs, America’s biggest financial institutions may finally be coming back.  The market was encouraged by a flurry of investment banking activity, from Warren Buffett’s $23 billion takeover of Heinz to the $11 billion merger between US Airways and AMR Corp., and many in the financial media wonder whether a new golden age for M&A has begun.  Stocks of America’s bulge bracket investment banks are sitting at multi-year highs.  In a recent segment on CNBC, Jim Cramer claimed that we are now in a state of "merger mania," and that the corporate confidence needed to revitalize the M&A market is back.  If he’s right, these banks may prove be worthwhile investments for your portfolio.

On the road to recovery

Diversified financial institutions including Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), and JPMorgan Chase (NYSE: JPM) provide a wide range of financial services.  These include corporate finance activities such as mergers and acquisitions, as well as accessing the debt and equity markets on behalf of their clients.  Services such as these give corporations necessary financing.  When the global economy entered the throes of the Great Recession, corporations held their purse strings tightly and institutional finance activity ground to a halt.

Now that the global economic recovery finally appears to be on solid footing, corporate finance has resumed (albeit at a slow pace).  Share prices and valuations of Goldman Sachs, Morgan Stanley, and JPMorgan are expanding and each of these stocks now enjoys reasonable market multiples.  Goldman Sachs and JPMorgan trade near or above book value.

Goldman Sachs reported full-year 2012 net revenues of $34 billion and net income of $7.48 billion.  Diluted earnings were $14.13 per share.  JPMorgan reported solid fourth quarter results: revenues rose 10% on the strength of a 33% increase in mortgage originations. In addition, earnings per share of $1.40 handily beat estimates of $1.16 per share.  Full-year 2012 earnings were a record $5.20 per share.  Meanwhile, Morgan Stanley’s full-year net revenues were slightly more than $26 billion, with income from continuing operations clocking in at $1.59 per diluted share.

At current prices, Goldman Sachs, JPMorgan, and Morgan Stanley exchange hands for 10, 9, and 14 times their 2012 earnings.  As a result, these stocks aren’t carrying excessive valuations and might be considered value plays within the financial services sector.

Not a good fit for every investor

If you’re interested in allocating capital into the financial sector while gaining exposure to the global economic recovery story, these stocks should be of interest to you.  At the same time, you’ll need a thick skin to endure the frequently volatile swings in the share prices of these three firms.  Goldman Sachs, Morgan Stanley, and JPMorgan all hold betas higher than 1.5, meaning for every 1% move in the broader market, these stocks should be expected to move 1.5% in the same direction.

Furthermore, investors who rely on income may want to favor JPMorgan above Goldman Sachs or Morgan Stanley.  JPMorgan pays the highest dividend yield of the three and is the only stock among them to carry a yield that surpasses the yield on the S&P 500 index.  At current prices, JPMorgan yields 2.5% while Goldman Sachs and Morgan Stanley yield 1.3% and 0.8%, respectively.

Bottom line

While the reported results for each of these three stocks are moving in the right direction, it remains to be seen whether we can collectively breathe a sigh of relief toward the financial sector.  Corporate finance activity seems to be steadily coming back, and while these stocks might prove to be great investments, you’ll need to have a strong disposition to be in these names for the long haul. 

If you’re a buy and hold investor, make sure you have the right mindset.  Understand that these financial institutions will likely exhibit more volatility than many other sectors, and make your investment decisions accordingly.

rciura has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of JPMorgan Chase & Co.. 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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