By: Ahmed Ishtiaq
Financial stocks made a remarkable recovery during 2012, and the bank stock index gained 3.2% compared to a 2.4% gain for the Dow Jones Industrial Average. Furthermore, financial stocks posted the biggest gains on a percentage basis in the S&P 500 index in 2012, up 29% in the last 12 months versus a 15% gain in the index. Stocks like Bank of America (BAC) and Citigroup (C) were the clear winners during the past year. Bank of America stock doubled during 2012 and Citigroup recorded gains of about 30%.
Investors may think there is little room for the financial stocks to grow since most of these stocks are trading close to tangible book value. Tangible book value is the liquidation value of a company not counting intangible assets such as goodwill. Most of the financial stocks have traded at a substantial discount to tangible book value since 2011. The only exception has been JPMorgan Chase & Co. (JPM).
However, I believe there are still some financial stocks that can generate substantial returns over the next year. I have tried to identify three financial stocks which I believe will outperform during 2013.
Capital One Financial Corp
- Capital One Financial (COF) is a diversified financial institution. It is one of the largest issuers of Visa and MasterCard credit cards in the United States, and it is one of the largest depositary institutions in the U.S. In addition, the firm has an auto finance segment and a global financial services segment, which includes foreign credit cards and other lending such as small-business loans.
- Capital One has grown its revenues substantially over the past three years. In each of the past two years, revenues stood above $16 billion. However, trailing twelve months revenues have made a big leap and currently stand at $19.8 billion.
- Cash flow generation is extremely solid for Capital One. At the end of last year, cash flows from operations stood at $7.4 billion. However, trailing twelve months operating cash flows stand at $9.6 billion.
- At the moment, the stock is trading at a price-to-book ratio of 0.9, offering significant upside potential. Furthermore, mean analyst estimate of EPS for 2013 is $6.99. Analyst estimates indicate growth in EPS of about 7% over the next year.
- Credit cards were the main business for Capital a decade ago, and main sources of revenue were interest, service fees and securitization income. However, Capital one has diversified its product line recently. Now the firm also offers auto loans, and it has expanded its operations beyond the borders of the U.S.
- Capital One has one of the largest databases of consumers, and the firm uses it efficiently to tailor products according to the needs of consumers. This strategy has given the firm a unique advantage and it has achieved phenomenal growth over the years. The firm acquired the credit card operations of HSBC, which helped it grow its revenues. As a result, COF's Basel I Tier 1 common ratio went up to 10.7%, up 80 bps from the previous levels.
- BlackRock (BLK) provides investment management services mainly for institutional investors. The firm has more than $3.5 trillion in assets under management. The firm has diversified product mix containing equity, fixed-income, money market and multi-asset classes. BlackRock mainly uses passive strategies for assets under management.
- Revenue growth has been poor for BlackRock over the past three years. The firm reported revenues of $9.08 billion at the end of 2011, which has fallen to $9.02 billion over the past twelve months. However, basic EPS has gone up from $12.54 to $13.15 during the past twelve months due to a decrease in expenses.
- Cash flow generation has also been showing slow growth, and trailing twelve months cash flows from operations have come down. Trailing twelve months operating cash flows stand $67 million below the numbers reported at the end of 2011. However, free cash flows have grown and currently stand at $2.6 billion, compared to $2.58 billion reported a year ago.
- Huge amount of assets under management and a mix of active and passive strategies give the firm a unique edge over its competitors. Majority of assets for BlackRock come from institutional investors, which provides it certainty due to the stickiness of these assets. Furthermore, the firm has good geographic diversification and its clients come from more than 100 countries.
- For future growth, the firm is looking at frontier markets. BlackRock expects the frontier markets to show impressive growth over the next two to three years. The firm is looking at countries like Vietnam and Bangladesh, due to the low-cost structure of these economies.
- Mean analyst estimate of EPS for 2013 is $14.77. Analyst estimates indicate growth in EPS of about 6.2% over the next year.
- Banco Santander (SAN) is one of the world's biggest financial institutions. The bank has over $1.5 trillion in assets and close to 14,000 branches worldwide. The main focus of the bank is retail banking, which is about 75% of the operations. Banco Santander also has a wholesale bank and an insurance and asset management venture.
- Total interest income for the bank has taken a massive leap over the past twelve months. At the end of last year, the bank reported total interest income of €60.8 billion ($80.16 billion). However, trailing twelve months interest income has gone up to €83.9 billion ($110.62 billion).
- Cash flow generation is extremely strong for this giant. Current cash flows from operations stand at over €35 billion ($46.15 billion).
- The stock is currently trading at a price-to-book ratio of 0.8, offering a significant upside potential. Moreover, mean analyst estimate of EPS for 2013 is $0.60, compared to 0.45 for the last year. Analyst estimates indicate growth in EPS of about 33% over the next year.
- The bank has a great history of profitability expansion, and I believe it will continue to grow in 2013. Like most of the other financial institutions, Banco Santander has come out of the troubling times, and it can now focus on growth.
Margins and Multiples
Instead of talking about the margins and multiples of these companies in above paragraphs, I have decided to put these metrics in the table. It should make the reading and comparison easier.
Debt to Equity
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.