I am convinced that financial companies are the place to be when an economy starts growing again. Delinquency rates fall and banks can expand their balance sheet with a much better risk profile. As a result, net profits soar. This is especially true in the US where the 2009 crisis crippled the sector for over four years and, hence, the upside potential is the greatest. Here, I present one three-stock portfolio of US financial companies, including the percentage of funds I would allocate to each stock. It is the best risk/reward adjusted equity portfolio I could find at current market prices.
The U.S. bank portfolio
Citigroup Inc (NYSE:C) trades cheaply at just 0.9 times tangible book and 10.5 times 2013 earnings. I would go long Citi, taking into account the positive outlook that will be faced by most of the bank’s business branches.
While Citigroup Inc (NYSE:C) is still digesting the drag from Citi Holdings (which generated a loss of $0.26 per share in the last quarter), this “bad asset portfolio” is being wound down fast. In just a quarter, assets decreased from $156 billion to just $149 billion. Most importantly, the bank is seeing a tremendous improvement in credit quality. Net charge-offs have come down 13 quarters in a row and non-performing assets for 11 of the last 12.
By next year, I expect Citigroup Inc (NYSE:C) to be in an unimpeachable position in terms of capital and asset quality. As a result, I would expect authorities to permit the bank a share repurchase and an increase in its dividend (currently Citi pays a 0.08% cash yield).
Since its my favorite US banking stock, I would assign Citigroup Inc (NYSE:C) a 45% portfolio weight.
Discover Financial Services (NYSE:DFS) is a direct banking and payment services company that operates two banking subsidiaries: Discover Bank and Bank of New Castle. The company’s financial results and prospects could not be better.
As a matter of fact, Discover reported 1Q’13 EPS of $1.33, beating the consensus of $1.12. More importantly, each major area of the P&L largely surpassed expectations: Discover Financial Services (NYSE:DFS) reported better revenue, lower expenses, and lower provisions.
The company is not only doing great, but is also behaving accordingly with its shareholders. During 1Q’13, Discover repurchased 6 million shares for $238 million and increased its quarterly dividend 43% to $0.20 per share, making for a 17% payout ratio. Discover’s board has also approved a two-year share buyback plan, to the tune of $2.4 billion.
Trading at 9.9 times 2013 earnings and paying a 1.7% cash dividend, I think Discover Financial Services (NYSE:DFS) is a clear bet for anyone who wants exposure to the US financial industry.
Even when Discover Financial Services (NYSE:DFS) is not one of the biggest financial institutions in the US (its market capitalization is $23 billion), I would assign the company a 30% portfolio weight.
Metlife Inc (NYSE:MET) is a global insurer (with operations in over 60 countries) but it is, above all, a US financial company. A few days ago, it was the company’s annual investor day. The most important highlights were around the management’s commitment to increasing the capital efficiency of MetLife’s businesses over time. I can not help to trust Met’s management when they have been driving such outstanding results.
For the first quarter this year, Metlife Inc (NYSE:MET) reported 1Q’13 operating EPS of $1.48, well ahead of the consensus estimate of $1.30. According to the company’s reports, “The main source of the beat was strength in Asia, U.S. retail, and EMEA, which more than offset a modest shortfall in Latam and Group Benefits.”
Trading at 7.7 times 2013 earnings and 0.88 times book value, Metlife Inc (NYSE:MET) pays a 2.62% cash dividend yield and has a $600 million expense savings goal in place. I think the stock is a great idea if you want exposure to U.S. insurers.
Since Metlife Inc (NYSE:MET) is the only insurer in the portfolio, I would assign the company a 25% portfolio weight.
The bottom line
The portfolio above is well-diversified across the U.S. financial industry, given that it has been built with only three companies, and provides good value. Even if the portfolio currently pays a (very low) 1.2% cash dividend yield, it gives you great upside potential going forward, given that financial companies should be raising dividends fast when the economy finally stabilizes.
Federico Zaldua has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup Inc (NYSE:C).
The article U.S. Financials: 1 Proposed Portfolio originally appeared on Fool.com.
Federico is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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