We are almost in the middle of the earnings season, with results from more than 250 S&P 500 members already out. Major Banks on the index (accounting for nearly 45% of the Zacks Finance sector‘s total earnings) reported 2.4% year-over-year earnings growth. This compares unfavorably with 6.5% growth registered in the prior quarter.
Major banks’ results in fourth-quarter 2017 were aided by an improving economy, higher interest rates and a slight rise in lending activities. Apart from these, strength in investment banking, a strong balance sheet and solid asset quality offered support. But these were not enough to boost their financial performance.
Factors that weighed on major banks’ third-quarter financial performance persisted in the fourth quarter as well. These include trading weakness and slowdown in mortgage banking. Also, increased investments in technology to enhance digital offerings led to elevated expense levels.
On top of these, earnings were adversely affected by huge one-time charges related to changes in the tax law, though the act will result in gains for banks over the long term.
Wondering why should one invest in major banks despite dismal fourth-quarter performance? Well, there are several factors that will likely lead to improved performance for these banks going forward.
Factors to Drive Earnings
Firstly, if the Federal Reserve sticks to its plan of increasing rates three times in 2018, it will further help banks in expanding net interest margin. This along with rise in loan demand will eventually drive revenue growth.
In case the inflation rate improves (the latest data indicates some improvement), there are chances of aggressive rate hikes by the Fed next year. So, banks are anticipated to benefit more.
Secondly, while all sectors are likely to benefit from the lower tax rates, major bank are expected to gain the most because they are amongst the highest tax payers in the United States.
Also, driven by the tax legislation provisions related to repatriation of overseas cash, banks will be in a win-win situation. This is because, as overseas cash is brought back, it will likely provide an impetus to M&As activities, thereby giving a boost to investment banking. Also, as the act will lower tax rates for wealthy individuals, asset management units of these banks are projected to witness a rise in fund inflow.
Finally, growing investor optimism about reduced regulations is likely to boost bank stocks. Once there is a reduction in the number of banks tagged as systemically important financial institutions, the compliance costs for the major banks will decline.
Major banks’ earnings are expected to accelerate in 2018 with 22.7% growth compared with 7.1% rise for the Finance sector. Also, we note that the industry is currently positioned at the top 6% out of the 250 plus Zacks industries. Our back-testing shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than two to one.
Also, major banks seem undervalued compared with the broader finance sector. The industry’s current price-earnings (F1) and price/book ratios of 12.6 and 1.8, respectively, are lower than the finance sector figures.
Therefore, we believe investors will benefit by betting on major bank stocks, as the industry is likely to perform better in the near term.
Picking the Potential Winners
Not all major banking stocks appear to be wise investment options at the moment. Investors need to pick those stocks that have witnessed robust growth and still have plenty of upside left.
With the help of the Zacks Stock Screener, we have selected major banks with Zacks Rank #1 (Strong Buy) or #2 (Buy).
Further, over the last four weeks, these stocks have witnessed a positive estimate revision of 5% or more. Also, the banks are projected to record earnings growth of 20% or more in 2018. To cut short the list further, we have chosen those banks that delivered a positive earnings surprise in the fourth quarter.
Here are the five major bank stocks worth betting on now:
Bank of America Corp (NYSE:BAC), with a Zacks Rank #2, has witnessed its current-year earnings estimates moving 10.8% upward over the last four weeks. Further, the bank delivered an earnings surprise of 6.8% in the quarter. The company’s 2018 earnings are projected to grow at the rate of 34.4%.
Sporting a Zacks Rank #1, Comerica Incorporated’s (NYSE:CMA) 2018 earnings estimates have risen 12.5% over the last 30 days. The company came up with an earnings surprise of 2.5% in the quarter. Further, the bank’s 2018 earnings are projected to grow at the rate of 32.9%.
Current-year earnings estimates for JPMorgan Chase & Co. (NYSE:JPM) have moved 11.3% upward over the last 30 days. The bank, carrying a Zacks Rank #2, pulled off an earnings surprise of 4.1% in the quarter. Further, it 2018 earnings are projected to grow at the rate of 28.8%.
PNC Financial Services Group Inc (NYSE:PNC), with a Zacks Rank #2, has witnessed its current- year earnings estimates moving 8.5% upward over the last four weeks. Also, the bank delivered an earnings surprise of 4.1% in the quarter. The company’s 2018 earnings are projected to grow at the rate of 22.2%.
SunTrust Banks, Inc.’s (NYSE:STI) 2018 earnings estimates have risen 9.3% over the last 30 days. The bank, carrying a Zacks Rank #2, pulled off an earnings surprise of 3.8% in the quarter. Further, it 2018 earnings are projected to grow at the rate of 24.5%.
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