Banks seem to be the companies that everyone loves to hate these days. Many politicians and journalists are still bashing the banks for helping cause the financial meltdown in 2008. And those who have finally moved beyond 2008 are now criticizing the banks for a whole new panoply of sins such as being too restrictive in their lending policies, being too lenient in their lending policies, taking too many risks, not taking enough risks, etc. (Politicians and journalists do not appear to be very concerned with being consistent.)
For investors who have been brave (or contrarian) enough to venture into bank stocks, they have been quite rewarding. For example, Bank of America stock has quadrupled from its low in 2009, and since the end of 2011 it is up by 119%. Despite this type of gain, we believe that the bank stocks have a lot further to run. It probably won’t happen overnight, but if you are willing to buy and hold some bank stocks for several years, you should be handsomely rewarded.
There are a number of reasons why we like banks right now. First, they are cheap by historical measures. A number of banks today are still trading below book value; just a few years ago, many traded at two or three times book value. Second, loan growth (which, as long as the loans are made prudently, leads to profit growth) is likely to accelerate as the economy continues to improve and lending polices become a little more liberal. (After the 2008 financial collapse, many banks became ultra-conservative; in other words, closed the barn door after the cow was already out.)
Another reason we like the banks is that they are generally faring well on the government’s “stress tests” (which are probably another example of closing the barn door too late, but that’s another story). This means that the banks are less risky than in the past. Moreover, after a bank passes its stress test, the government is likely to allow it to raise dividends and initiate stock buybacks – both of which should boost the stock price.
Finally, we think banks will benefit when interest rates eventually begin to rise. With rates held low by the Federal Reserve, lending margins have been compressed, which holds down profitability. As rates rise, margins should expand, leading to more profits. The banking industry stock picks recommended in our subscriber-restricted article are a mix of money center banks and regional banks that have strong business franchises and that we think could be particularly rewarding for investors.
Read the April 2013 Turnaround Letter to read our ten financial sector stock picks.