When we look at stocks, we primarily do so from a value perspective. We do keep concepts like market sentiment and branding in mind, but we mostly use those factors to mentally adjust how appropriate the relative value of a stock is. Value analysis focuses on stocks which are trading at a low level relative to their trailing earnings (using trailing earnings as a neutral to conservative estimate of future earnings, which is what actually determines the appropriate value of a company’s equity) or, in the case of some sectors or industries, the book value of the company’s equity. Of course, the theory that trailing earnings are a conservative estimate of future earnings works best when the company has been showing growth in revenue and/or earnings, and so that is also something to look for. Here are five stocks from the financial sector which we think that investors should be considering:
We track 13F filings from hedge funds and other notable investors as part of our work researching investment strategies (the most popular small cap stocks among hedge funds, for example, outperform the S&P 500 by an average of 18 percentage points per year). Using our database we can see that out of all the stocks in the market, American International Group Inc (NYSE:AIG) was the most widely owned stock out of the investors we track in the fourth quarter of 2012, surpassing Apple (see more of the most popular stocks among hedge funds). While the smart money likes AIG, the stock is underowned by mutual funds who have been slower to forget the company’s troubles during the financial crisis. Currently American International Group Inc (NYSE:AIG) trades at only about 60% of the book value of its equity, so in theory the downside to buying the stocks should be limited. We would think a P/B ratio of 0.7 to 0.8 would be more appropriate.
When we look at the most popular financial stocks among hedge funds, a number of the top slots are taken up by megabanks. Some of these we’re not as comfortable with because their recent performance haven’t been good and so the value is dependent on improvements in the financials. JPMorgan Chase & Co. (NYSE:JPM), however, boasts a trailing earnings multiple of 9 and a P/B ratio of 0.9. In addition, the company seems quite healthy with a 53% increase in net income in the fourth quarter of 2012 versus a year earlier. A dividend yield of over 3% is also a plus as it serves to return cash to shareholders.
Big banks are hogging all the attention of value investors (and the anti-finance crowd), but there’s a good selection of cheap regional banks as well. Regions Financial Corporation (NYSE:RF), which serves the southern and parts of the midwestern United States, has climbed to a market capitalization of over $11 billion in the last year, so it’s a bona fide large cap. It trades at a significant discount to the book value of its equity with a P/B ratio of 0.8 and its earnings multiples are low in absolute terms (and only slightly above what we see at the more stable megabanks such as JPMorgan Chase & Co. (NYSE:JPM)).
Credit card stocks like Visa have been solid performers in the last year, but that company looks a bit pricy at 20 times forward earnings estimates. While Discover Financial Services (NYSE:DFS) doesn’t have Visa’s brand power, its P/Es- both on a trailing basis and for the fiscal year ending in November 2014- are both 10. With Discover Financial Services (NYSE:DFS) being that much cheaper than its larger peer, and with revenue and earnings both up moderately in its most recent quarterly report compared to the same period in the previous fiscal year, we think it meets all the criteria for a prospective value stock.
Capital One Financial Corp. (NYSE:COF) rounds out our list of intriguing financial stocks. Capital One combines a bank holding company and a credit card business. It too carries a moderate discount to book value. Though earnings per share did decline in 2012 as the company issued shares, this looks to have been caused primarily by M&A-related charges. Even if we allow those charges to hit earnings for the year, Capital One Financial Corp. (NYSE:COF) trades at only 9 times trailing earnings; analyst expectations for growth over the next several years imply a five-year PEG ratio of 0.9.
Certainly many of these financial stocks have considerable exposure to the broader market, so it’s not wise to go out and buy all of them if an investor is already long a number of high beta stocks. However, each of them looks cheaply priced to us- either in terms of their trailing earnings, their book value, or both- and with their businesses on a solid footing as well, we think that they are good value stocks at this time.
Disclosure: I own no shares of any stocks mentioned in this article.
