"I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over."
--- Warren Buffett
By Richard Saintvilus
I appreciate the significance Mr. Buffett's message. In other words, let's stop making thing harder on ourselves than they need to be -- investing is hard enough as it is already. With second-quarter's earnings season upon us, I've begun to reshuffle my portfolio to find hidden opportunities.
As such, I've found several gems in the financial sector. While banks have been some of the strongest performers in the first quarter, recent earnings and an improving economy suggests that more gains are on the way. Here are a few names to consider.
JPMorgan Chase (JPM)
One can't discuss JPMorgan today without mentioning the embarrassing London Whale trade. Still, management deserved credit for having acted quickly to mitigate the damage. For some investors however, JPMorgan's recovery has appeared too slow. Consequently, the stock has not traded on fundamentals.
However, though, the bank is coming off an excellent fourth quarter where the company surprised the Street by posting net income of $5.7 billion or $1.39 per share, which compared favorably to the $3.7 billion or 90 cents per share in the year-ago quarter - EPS surged 54%.
Mortgage banking remained solid with loan originations rising by 33% to $51.3 billion. It is clear that JPMorgan has a strong business and a solid franchise in investment banking, mortgages and retail banking. If the bank can continue to produce solid return on equity in the low to mid single digits (12.5%) coupled with a discount rate of 9.5%, there is no question that fair value on the stock should be around $58.
As I've been saying for while now, the stock remains undervalued by (at least) 20%. And when coupled with the potential for share buybacks over the next several quarters and an improving balance sheet, this stock may still be the cheapest bank on the market.
Wells Fargo (WFC)
Next on the list is Wells Fargo. I will concede that the bank's third-quarter earnings results were not up to its usual standards. But relative to expectations it wasn't all that bad. Besides, the performance was still enough to continue what is now 11 consecutive quarters of profit growth - posting $4.9 billion in Q3. Not only was this a company record, but it also represented year-over-year increase of 22%.
Wells Fargo consistently demonstrates solid execution and leverage. Unlike most rivals, management has figured out ways to produce meaningful returns in both assets and its investments. This is despite prolonged weakness in interest rates. What's more, the bank continues to benefit from a business that is unburdened from unfavorable risk.
The fact that it has limited exposure abroad is also a good positive, which minimizes impact from European fiscal concerns.
Finally, while most banks tend to fall in within the same category and thereby appraised on similar standards and metrics, it is clear that Wells is out to set itself apart from the rest. There's a premium placed for banks with above-average growth prospects that still meets certain criteria of safety.
From that standpoint, Wells Fargo meets all of the requirements. From an investment perspective, the stock is trading at a considerable discount. Investors should expect gains of 20% as the stock should reach $40 fairly quickly.
Citigroup has been a tough name to figure out. Analysts want to love the company, but there are still some risks that have prevented the Street from diving in head first. However, though, the bank is beginning to show signs of a good turnaround story. In its most recent quarter, Citi posted net income of $1.2 billion, or 38 cents per share on revenue of $18.7 billion. When excluding items, the bank earned 69 cents per share.
Citigroup missed on both top and bottom lines as analysts were expecting revenue of $18.82 billion. But let's have some perspective.Although Citi's Q4 performance does not match up well with JPMorgan's, relative to expectations it was pretty good.
Plus, considering the adverse impact of the legal charges and foreclosure settlements, Citi actually outperformed both Bank of America and Wells Fargo. Bears argued that Citi's revenue arrived pretty light. But 9% growth in a tough economy shouldn't be discounted, either. The company was able to do this despite several legal battles and charges, including payments of $2.32 billion related to layoffs and lawsuits.
Investors have to realize that Citi is changing. To that end, management has a clear plan to turn things around - remarkably, much quicker than analysts might expect. Even better, risks are being lowered. The stock is attractive relative to its books value and if Citi can continue to grow profits in the mid-20% range, the stock should eclipse $50 by the second half of the year.
Bank of America (BAC)
Bank of America has been feeling very confident lately to the extent that its board of directors recently approved a stock buyback program valued up to $5 billion in its common stock and $5.5 billion in its preferred stock. After successfully passing its stress test, the bank had an extra "pep in its step." Much deserved!
While Bank of America is not out of the woods yet from previous mistakes, the bank has been working hard to clean up its messes. The good news is, in the process, it has removed several uncertainties related to profitability. What's more, that the consumer and business banking segments posted net income 15% higher demonstrates BofA's strong brand recognition.
It also means that despite the advancement of JPMorgan and Wells Fargo, BofA is not ceding market share, which refutes a popular cited bear argument. Furthermore, the bank is doing everything possible to assure investors that growth will continue over the next several years.
This includes a head count reduction in Q4 by about 5,000 employees in an effort to lower expenses. This is in addition to closing a few local branches that were underperforming. Clearly, the bank now has a blueprint toward sustainable growth.
As it stands, these shares are still discounted to the bank's tangible book value. While it is clear that Bank of America is not getting the benefit of the doubt here, it is also very evident that progress is being made.
Here's making sense
While there are often legitimate concerns to avoid bank stocks, each of these names are now moving in the right direction. While they are not all the same, the fact is, they make too much money to not be considered. That said, I would assess these names on a quarter-by --quarter basis. Let's not make this more difficult than it needs to be.
Additional disclosure: SaintsSense is a team of financial writers. This article was written by Richard Saintvilus, one of our tech analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.