4 Financial Stocks to Buy Now: 1 May Double in Value
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Due to a significant level of perceived risk, financials are trading at unusually low levels compared to the broader market. While the Shiller PE ratio currently stands at 21.4x, financials are commonly priced below 10x earnings. Growth expectations may not be the greatest, but they are enough to offer a substantially high margin of safety. High betas will also help drive outperformance in the event of a quicker-than-expected full recovery.
I am currently bullish on Wells Fargo (NYSE: WFC), Regions Financial (NYSE: RF), US Bancorp (NYSE: USB), and KeyCorp (NYSE: KEY). Wells Fargo trades at just a respective 11.3x and 9x past and forward earnings with a 2.7% dividend yield. Over the past 5 years, the company grew EPS annually by 2.7%, and 11.3% is expected for the next 5. This means that the company will have 2016 EPS of around $4.83. At a 13x multiple, the future value of the stock is $62.79 - almost double the current valuation. A 12% discount rate would place the price target at $35.63.
In my view, the 9.7% annual growth expectation for Wells Fargo is too bearish. In the period surrounding the financial crisis, the company still grew by 2.7%. Net income tanked to $2.7 billion in 2008 and had a significant amount to recover. Moreover, I find the 12% discount rate to be overly high given the bank's conservative reliance on mortgages and diversification away from Europe's sovereign debt crisis. Improvements to capital ratios will help investors recognize Wells Fargo's cheapness and unsuspecting safety.
Regions trades at 8.4x forward earnings and nearly half of book value. 2.4x free cash flow also makes the stock cheaper than what the "hold" rating on the Street would suggest. 8% annual EPS growth is expected over the next 5 years, which means 2016 EPS of $1. At a 13x multiple, the future stock value of the company will double to $13. A 12% discount rate puts the price target at $7.38 for less than a 20% margin of safety. With more than 50% volatility than the broader market, Regions is thus a strong, albeit risky bet, on a full recovery.
More local decisions on the corporate level can enhance value creation prospects. US Bancorp recently announced that it was raising overdraft fees to typical industry levels. Consumers have gotten used to banks hiking these charges, so I don't think US Bancorp's decision to do the same after years of keeping them low will make much of a difference on volumes. The company has also shown a greater willingness to make riskier investments, such as those in solar panels.
US Bancorp has also introduced mobile payment solutions, like the Ace Rewards Visa Application for iPhone Users, in addition to partnering in the credit card application space. Consumer spending, in my view, will grow quicker-than-expected as tax rates are cut. As it stands, the company trades at just a respective 12.3x and 10.7x past and forward earnings with a dividend yield of 2.4%.
KeyCorp is cheaper than US Bancorp but comes with lower growth and a lower beta, which may hold back outperformance. The money center bank trades at only a respective 8.2x and 9.4x past and forward earnings with a 2.6% dividend yield. Analysts rate the stock closer to a "sell" than a "buy" according to data from FINVIZ.com. The price target of $8.67 is also not meaningfully higher than the current price target.
With that said, I find the expectations for 5.2% annual EPS growth over the next 5 years to be, again, bearish. At only 0.7x book value, KeyCorp has plenty of room to grow into. I was encouraged to see loan growth continue in financial, agriculture, and commercial lines. Americans are cautious about spending right now, but their demand for credit access will soar when greater economic certainty emerges. I encourage investors to buy shares before higher growth is factored into the stock.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of KeyCorp and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.
