The big banks have been on a roller coaster ride. From soaring heights pre-Global Financial Crisis (GFC) to almost being wiped off the face of the planet, it is fair to say it has been volatile for banking sector.
As an investor, though, it is critical to be able to take that proverbial ‘step back’ from the noise and be able to objectively evaluate potential investment situations. A successful investor has the ability to evaluate a possible investment based not on what has been but what may lie ahead. It is important to remember that returns occur in the future, not what has been.
When I look at the big banks, there are three that appeal to me as potential investment opportunities.
First of all is Bank of America. After reaching heights of some $50 plus per share just prior to the all-out chaos of the GFC, BAC then collapsed to a low of a tick over $3. Losing 95% of its value in just a few months, many a BAC investor was permanently scarred. After the TARP injections, Bank of America managed to survive, and since its 2009 lows has climbed back to be currently $12 a share.
Something I find interesting is that many ordinary investors see BAC and say ‘look, it fell from $50 to $3 a share in just a few months!’ Few recognize that yes whilst that is true, it also moved from $3 to $18 a share in 2009 in virtually the same time frame it took to collapse. Canny and dispassionate investors had the potential to pick up gains in the order of 500% in that time.
What primarily interests me about Bank of America is it is trading at significant discount to Book Value. Currently at $12 the stock is has a Price-to-Book of just 0.6. I understand the hesitancy that many have to believing the stated value of the big banks balance sheets. However, my personal view is that current valuations of bank’s book value have already factored in significant discounts given the terrors of the GFC still echo in people’s minds.
In fact, I would go as far as to say the stated book values of the big banks are more conservative now than they were in the period 04-07. My view is the excesses and overly optimistic projections and assumptions have and truly been washed out of Book valuations.
With this in mind, a Price-to-Book of 0.6 to me represents a significant buying opportunity in Bank of America. Even assuming absolutely zero growth in Bank of America’s earnings and just a gradual repricing of the stock back to a P/B of 1 would see the stock appreciate by $8 to a price of $20.
Relative to the current price of $12 this is a 66% gain. Even if this repricing took several years, this would still be a very respectable return.
Citigroup Inc. (NYSE:C)
I see the same situation showing in Citigroup Inc. (NYSE:C). Currently at $44, C is trading at a P/B value of just 0.72.
As with Bank of America, assuming zero growth in earnings and just a gradual repricing of the stock to a P/B Valuation of 1.0 would see a stock price of $61 – representing a gain of 38%.
I understand many will read this and think I am mad to consider investing in the mega banks. I respect that, I also respect that these banks have been transformed and reengineered in the post GFC period. Bank of America and Citigroup have had 5 years now to write off bad debts and make provisions for potentially additional bad debt.
As well as this long period of clearing the decks of questionable debt, Bank of America and Citigroup Inc. (NYSE:C) are now flush with cash. Billions of dollars of surplus cash is sitting idle on the balance sheets waiting to be deployed should investment opportunities arise.
American International Group, Inc. (NYSE:AIG)
Whilst BAC and C are appealing, the mega bank in my view that offers the best potential for returns is American International Group. What was the poster child for wiping out shareholder equity in 2008, is now in my opinion a prime, long term investment opportunity.
With a P/B Valuation of just 0.56, AIG could well be a winner for those prepared to ride the inevitable bumps over the next few years. As with BAC and C, assuming absolutely no earnings growth and a gradual repricing to a Price-to-Book of 1.0 AIG well might see growth from its current price of $38 to a respectable $67 (a retirement fund boosting potential return of 76%).
With these investment ideas outlined above I have not even considered the possibility should the market become somewhat more optimistic and favorable in its view and pricing of the mega banks. I have only worked off the figures of a P/B of 1. Imagine the potential returns should Price-to-Book valuations reflect a market view of growth and high quality balance sheets!
The article Who Are You Banking On? originally appeared on Fool.com and is written by Jarrod Bailey.
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