A Diamond in the Rough
Dave is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The banking industry is a tough world right now. You could go down the long list of challenges: low interest rates, heavy regulation, additional capital requirements, etc. However, as is almost always the case, some companies are able to shine through those dark clouds.
I've been a big fan of Bank of the Ozarks (NASDAQ: OZRK) for some time now. When Bank of the Ozarks recently reporting earnings, they once again showed how strong they are. Their shareholders were rewarded with a 8.6% jump in share price on the first day of trading post-earnings.
I wrote back on June 26 about FDIC-assisted acquisitions fueling their growth. Bank of the Ozarks grew up organically, but lately benefited from receiving a relatively low-risk new book of business from failed companies given to them by the FDIC. While they had no FDIC-assisted acquisitions in Q2, their results were still fantastic, showing their ability to still grow organically. I won't rehash all the details (earnings release here), but here are a few highlights:
- Loans and leases, excluding covered loans, increased 10%
- Deposits increased 10.4%
- Net interest margin for the quarter of 5.84%
- Non-performing loan ratio of 0.50%
Just those metrics alone show a powerful combination of growth and quality. Volume (loans and deposits) is increasing, while quality (net interest margin and non-performing loans) is outstanding. Also, please don't be fooled by any headline emphasizing the decrease in year-over-year earnings. Their second quarter last year included an FDIC-assisted acquisition that resulted in a large, one-time gain.
The consistency (and growth) of Bank of the Ozarks provides a great opportunity for investors to ride out any potential storm that may be on the horizon (fiscal cliff, Euro collapse, slowing US growth, etc.). Just look back at history and you'll see a company that has risen from about $5 a decade ago up to $33 currently. And they'll pay you a 1.7% dividend along the way. This hidden gem is a great stock to buy if it gets taken down in a broad banking industry sell-off.
Alternative: BB&T
Bank of the Ozarks only has a $1 billion market cap. If you are looking for a larger company with good quality assets, I suggest BB&T Corporation (NYSE: BBT). BB&T has a $22 billion market cap and a P/E of 14.9 (higher though than Bank of the Ozark's 10.9) and a solid 2.6% dividend yield. They had their big stock price run in the 90s, and have stayed in a fairly tight range over the past decade, with the exception of course of 2008 and 2009.
The big reason that I like BB&T is because of its 4% net interest margin. While the earnings growth clearly has been non-existent over the past decade, the net interest margin in combination with its 2.6% dividend provide stable income that you can bank on (yes, pun). This stock is a good buy on weakness, especially since it would cause the dividend yield to rise.
Avoid:
Not all banks are doing quite so well. here are a few that I would avoid altogether:
Regions Financial (NYSE: RF) operates approximately 1,700 banks, mostly in the Southern U.S. Regions did expand its net interest margin in 2011 up to 3.1% from 2.9% in 2010. However, Regions has yet to recover at all from the 2008 sell-off. Back in 2007, Regions' stock could be found in the $30s. Now, it is struggling to get back up to $7. It's declining revenue trend is further reason to stay away. If they can start to increase revenue, then it will be worth taking a look a Regions stock.
KeyCorp (NYSE: KEY), based in Ohio, operates in banks accross 14 states. Similar to Regions, KeyCorp has yet to recover from the 2008 sell-off and has a declining revenue trend. It's stock is still struggling at the $8 level. Also, their net interest margin actually declined slightly from 3.16 in 2010 to 3.09 in 2011. Again, I need to see some revenue growth to jump into KeyCorp stock.
Bottom Line
Whether or not bank stocks are cheap remains a hotly debated topic. Regardless, buying a lesser quality bank because it looks cheap compared to its book value can be a recipe for disaster. They can get even cheaper, all the way down to zero, or more likely, until they are acquired. However, you can avoid the short-term valuation debate altogether by acquiring bank stocks, such as Bank of the Ozarks, that display both growth and good earnings quality. A longer-term investor can buy such stocks and wait for bank valuations to return to their historic levels.
Zaegs has no positions in the stocks mentioned above. The Motley Fool owns shares of KeyCorp. 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.
