by Jeff Reeves | February 5, 2013 6:15 am
Financial stocks burned many investors amid the market mayhem of 2008-09. Then in 2012, big banks came roaring back at last with dramatic gains. So will the momentum last?
Not for some.
Even if you figure they will hang tough, it’s hard to imagine some of the high-fliers repeating their performance — the 100% gains for Bank of America (NYSE:BAC) and 50% gains for Citigroup (NYSE:C) have many investors skeptical after their amazing crashes and burns in the wake of the financial crisis and failure to retain anything close to pre-crisis stock pricing. And given the difficult regulatory environment and short-term troubles weighing on lending, it seems unlikely a secular recovery in financials could lift bank stocks significantly in 2013.
However, a handful of picks in the financial sector are looking particularly strong after earnings relative to their peers. And a few picks in the sector have unique circumstances that make them compelling value plays, even if growth might not be easy to come by.
Three financial picks I’m watching now are Wells Fargo (NYSE:WFC), American International Group (NYSE:AIG) and Banco Santander (NYSE:SAN). These might not be great buys right now at current pricing, but a 5% to 10% pullback could provide a great opportunity for entry.
Yes, that American International Group (NYSE:AIG) — the same one that went to zero thanks to various kinky financial products that imploded when underlying mortgages went south. The company whose former honcho Hank Greenberg took hubris to a new level by threatening to sue the U.S. government and urging AIG to come along for the ride a few weeks back.
But while AIG might never be a popular company in the minds of many Americans, your portfolio could benefit from making friends. If you can hold your nose and invest, here’s why AIG is a good stock to own right now:
Tax Benefits: When AIG imploded, it “gained” the benefit of applying tens of billions in losses to future profits to offset taxes — with carry-forward losses a large reason the company posted a profit in fiscal 2012, including a $17.7 billion benefit from the IRS. Billions more in tax benefits remain, and some can be used through as late as 2030. This is a huge competitive advantage as the company rebuilds.
Simple and Streamlined: AIG sold off a bunch of assets to repay U.S. taxpayers for the bailout. However, it’s important to note that the moves also streamlined operations and headcount is half what it was just a few years ago. Its financial products business is no more, nor is its health insurance segment thanks to the sale of Alico to MetLife (NYSE:MET). AIG currently is in the process of ditching its airplane leasing business. Now, AIG is a simple run-of-the-mill company with two main pillars to its business: life insurance on one side and property-casualty insurance for homes and cars on the other.
U.S. Insurance Prices Rising: There has been a general uptick in property-casualty rates nationwide, with hurricane-averse states including Texas and Georgia seeing home insurance rates rise by double digits. This is no fun for homeowners, but the general environment protects margins for the industry — including AIG.
Low-Interest-Rate Burden Won’t Last: Insurers put premiums to work by investing in low-risk assets while their cash isn’t needed by policyholders for payouts. Unfortunately, low interest rates severely limit the profits that idle cash can safely generate. AIG will benefit when the Fed tightens policies and moves rates higher, which could be as early as the end of 2013 or early 2014 if you try and read the cryptic central banks comments.
Valuation Is Fair: AIG trades for half of its book value, and a forward P/E of around 11. Insurance giant and Dow component Travelers (NYSE:TRV) is in the mid-10s, and Allstate (NYSE:ALL) is in the high 9s.
Buy Under $35: AIG is running hot after adding 18% in the last three months, and coupled with the general feeling that there market is in store for a pullback, I would be reluctant to jump in now near a 52-week high. There also are risks to profitability that include a meager return on equity and lousy margins that lack peers in the insurance industry. As such, I think it’s responsible to be patient and not chase AIG; a pullback of 8% or 10% to the $35 range could give a great long-term entry point. News of another divestiture or of a dividend reinstatement could be a catalyst for a big move in the short term, and I remain convinced AIG has stabilized and has staying power in the long term.
Of course, watch AIG earnings at the end of February to either validate or refute these points.
Wells Fargo (NYSE:WFC) was one of the “best” financial stocks during the meltdown and quickly recovered from deep declines seen in 2008 and 2009. It hasn’t been as volatile as peers, and has delivered a respectable 30% since January 2010 while the S&P 500 has delivered roughly 35%.
If you’re looking for stability in financials, nothing is a sure thing. But Wells Fargo is about the closest thing to reliable that you’ll get out of bank stocks these days. Here’s why:
Wall Street Targets Neutral at Worst: Some 35 analysts on Wall Street are watching Wells Fargo stock right now, and every single one of them has a target above current prices, according to Thomson/First Call. Nobody is expecting a doubler here — the median target is $39 — and most have a “hold’ rating on WFC stock in the short-term. But long-term investing with a 12% annual profit is nothing to sneeze at.
Strong 2012 Earnings: Wells Fargo reported record earnings of 91 cents per share in January — a 25% jump from the previous year — along with a 7% bump in revenue and a 3% growth in deposits. Furthermore, charge-offs against bad loans were lower by 19%. Those are all very encouraging signs that WFC has its act together going forward.
Dividend: If you like financials but also like dividends, the pickings are slim. Except, of course, for Wells Fargo. The company boasts a 2.9% dividend yield and has a very sustainable (and “stress test”-approved) payout ratio of less than 30%. That means this dividend is safe, and could grow more in the years to come with that cushion between earnings and annual payouts.
Secular or Cyclical Beneficiary: Whether you believe we are in a secular bull market that will last for another decade or whether you believe this is just the beginning of a cyclical run before another pullback, Wells Fargo is the place to be if you want exposure. That’s because no sector is more fuel for a bull market than financials, which are intrinsically linked to economic activity via consumer and business lending. If the economy and the stock market gains momentum, so will healthy bank stocks. And if not? Then Wells Fargo’s stability will keep you whole when things get rocky.
Mortgage Giant: As of 2012, Wells Fargo had a piece of 1 in every 3 U.S. mortgages. That’s a mammoth market share — and while business isn’t as brisk now as it was in the early 2000s, the scale more than makes up for the lower quantity in the broader mortgage marketplace. This is a great position for WFC as the housing market continues to mend.
Buy around $33: Again, I think a short-term pullback is in order, but I don’t expect Wells Fargo to collapse, and I think it’s pretty fairly valued right now. If you want to wait until things cool off a bit, target the $33 area, which is about 5% downside from here.
This one might seem counterintuitive since EU banks aren’t exactly a pillar of health right now. But the clouds have started to part — and more importantly, Europe’s central bankers and politicians are intent on propping up the financial system.
And as we saw in the rebound of Bank of America and Citigroup, you can’t get more low-risk than a “too big to fail” lender with the full weight of the government behind it, can you?
Here’s why I like Santander (NYSE:SAN):
A Global Powerhouse: Santander is the largest eurozone bank by market capitalization. While there are short-term fears of continued debt crisis and economic troubles as even EU stalwart Germany slips closer to recession, unless you think a systemic failure is in order, it will eventually pay to have scale in Europe. Maybe not in 2013 or 2014, but eventually, Santander will have a powerful reach. Consider that Spain is only 15% of Banco Santander’s business with a lot of earnings coming from the rest of the EU, including Britain, as well as roughly half of profits coming from fast-growing Latin American markets like Mexico and Brazil.
Protected by the ECB: European Central Bank President Mario Draghi has been unequivocal of his support for eurozone banks and has pledged support through thick and thin. Couple that with reports that a host of European banks are paying back crisis-era loans from the ECB and you can see that even if Santander has some unforeseen difficulties, there is a big central bank with the will and the means to back it up.
Recent Writedowns: As Dan Burrows wrote for InvestorPlace.com, Santander had good news/bad news last week as it shored up its balance sheet by writing off some $26 billion in bad loans. The losses are hardly something to cheer, but it indicates that the bank is willing to admit defeat on a lot of its current portfolio. The result is a short-term anchor on SAN stock — including a 12% decline in the last week or so — but the prospect of putting the bad debt behind it at last and moving forward unencumbered now that the losses have been recorded. In short, earnings can only go up from here.
Giant Dividend: Like many foreign companies, Santander pays a volatile dividend that changes quarter to quarter. But based on annualizing the last four payouts, ranging between 14.75 cents and just over 23 cents, Santander has a roughly 9.1% dividend yield! Even if the low-water mark of 14.75 cents itself is annualized, the yield is about 7.7%. While the dividend might not seem sustainable in the light of recent losses and writedowns, Santander earned 82 cents in fiscal 2011 and $1.24 in fiscal 2010, so simply a return to the rather lackluster conditions of just a few years ago makes meeting the dividend very doable.
Buy Under $7: Santander’s price is a third of what it was in mid-2008. It’s down 36% in the last two years, including a double-digit plunge in the past few days. So it’s safe to say that calling a bottom here will be mighty difficult and that momentum still is clearly to the downside. However, barring the depths of EU shenanigans in mid-2012, it hasn’t dipped below the $6 mark since a brief period during the bear market lows of March 2009. I think $6 is the floor and would consider adding a position under $7 on a pullback. Sure, a lot can still go wrong with the eurozone … but what don’t we already know about? Not only is general EU uncertainty baked in by now, but the specific losses at SAN are now priced in. That means now could be a good time to stake out a position for a long-term, dividend-fueled ride in Banco Santander.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a positioni n any of the stocks named here.
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