It feels like forever ago that financial stocks were the 2017 darling of Wall Street.
Banks and other financials, represented by the Financial Select Sector SPDR Fund (NYSEARCA:XLF), led the broader market higher with roughly double-digit gains from New Year’s through the start of March. However, they’ve lost nearly all of those gains since, with XLF underperforming by 1% to 7.8% year-to-date, and other financial funds such as the Vanguard Financials ETF (NYSEARCA:VFH) are sitting close to flat for the year.
That pullback has come over increasing uncertainty about when President Donald Trump & Co. will push ahead with tax reforms and financial deregulation that was expected to jolt financial stocks to life.
Patience, patience. This pullback represents an opportunity to buy a few solid names in the space that will materially benefit from a rising-interest-rate environment — and when and if we do get tax legislation and the gloves taken off financial institutions, that’s all the better.
From here, these three financial stocks offer plenty of runway.
Financial Stocks to Buy Now: Wells Fargo (WFC)
Wells Fargo & Co (NYSE:WFC) remains a solid, long-term play in the financial space despite its troubles of the past year or so — troubles that have WFC trading about 5% in the red despite a slightly higher sector.
Wells has emerged from the recent sales practice scandal with a more focused directive on changing culture and incentives. Following a board investigation, management appears committed to putting this debacle behind it. Importantly, they have discontinued reporting the cross-sell metric as a measure of success for the retail bank, expanded training for our retail bank managers and bankers on acceptable sales practices, and sought to tie compensation and performance to customer experience.
WFC customers should start seeing the effects of this internal soul searching this quarter.
Wells Fargo has always been a historically conservative bank, which is why Wall Street clutched at its pearls when news of the bank’s employees opening 2 million phony accounts made headlines. But under normal circumstances, a bank like that reaps the benefits of a rising-rate environment without all the big swings.
In the first quarter, year-over-year figures in average consumer small business deposit balances were up 6% and while consumer checking account opens were down a hefty 43%. This was mitigated by a double-digit decrease in checking account closures, but as time progresses, patient investors will be rewarded as Wells Fargo builds back trust, and its customer base.
Financial Stocks to Buy Now: Charles Schwab (SCHW)
Charles Schwab Corp (NYSE:SCHW) is a growth stock, but occasionally it swings and also delves into value territory.
In the years immediately following the 2008-09 financial crisis, it was obviously the former — SCHW shares were halved amid the chaos. But value has turned into breakneck growth, with shares tripling in the past five years.
Schwab’s earnings power is primarily driven by growth in total managed client assets. And grow they have. SCHW has grown client account assets from $119 billion in 2012 to almost $200 billion last year, a 13% CAGR. This past quarter saw net new assets jump 22% to $39 billion, and total client assets climbed 14% to approach $3 trillion.
Earlier this year, SCHW lowered equity and options trade commissions from $8.95 to $4.95 and reduced the per contract option fee to $0.65. It’s clearly not at the Interactive Brokers Group, Inc. (NASDAQ:IBKR) level, but I would argue there’s not much overlap in customer base anyway. This will be a boon for migration to their trading platform.
The biggest catalyst for the Schwab thesis to work is an increase in short-term interest rates, or at least an expectation that short-term rates will increase. That is becoming a reality as the Federal Reserve brings up the fed funds rate, which should lead to new highs in EPS and share valuations.
The market isn’t pricing all of this in at the moment, however, with shares down a couple percent through five months of 2017. And while SCHW trades at 20 times projected earnings, those profits are expected to grow 20% next year, which is a fair value to me.
Financial Stocks to Buy Now: Northeast Bancorp (NBN)
Northeast Bancorp (NASDAQ:NBN) isn’t languishing this year. In fact, the stock is up by more than 50% so far in 2017, and yet it still trades at just 10 times forward earnings estimates.
Investors with a long view could enjoy a doubler by the end of next year should the earnings multiple expand to a still-reasonable 15.
NBN is a play on “Capital Crossing Bank Part II.” The head honcho at NBN is Richard Wayne, the founder of Capital Crossing Bank. Its focus on discounted, performing small-balance commercial loans led to $700 million in assets. They are incredibly savvy and true professionals. In 2010, FHB Formation LLC (run by Wayne) merged with NBN, where it continues to play to their strengths. There is diversity in collateral and geography (New York, California and New Jersey are top markets), and a unique foothold in the SBA 7(a) loan origination and sales business.
This is a $20 billion market that isn’t as competitive as other loan verticals. It also happens to be extremely profitable as much of these SBA loans are guaranteed by the government. So, originators often end up pocketing a high premium. Northeast Bancorp leads the pack, and Live Oak Bancshares Inc (NASDAQ:LOB) is the other major player. Incidentally, LOB commands an earnings multiple in the low 20s. Now, NBN is not 100% focused on this market, but given the expertise in their silo, the multiple still should better reflect this.
Northeast Bancorp is the most speculative buy of the group, but it’s also my favorite.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.