In comparing the 6 big banks, I wanted to use metrics that would indicate future performance rather than just reporting the past quarterly reports. Which banks are in the best position to grow revenue, market share and take advantage of new opportunities? There is change coming in the market with the threat/opportunity of increased interest rates. Is this to be feared or embraced as a new opportunity? Last, but most importantly, which company is going to provide the best return for its investors. Stock holders want to see a net gain on their investment. I talk net gain as the dividend paid and stock price appreciation in total return. There are many opportunities to gain 10% a year on your investment. What do these companies have to do to become the gem of your portfolio?
The 6 banks I include in this discussion are: Bank of America (NYSE:BAC), Wells Fargo & Co. (NYSE:WFC), JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc. (NYSE:C), Morgan Stanley (NYSE:MS), and Goldman Sachs Group Inc. (NYSE:GS)
In discussing the future, I must use some past data to set the starting point. I will go back to the 2Q, 2014 financial statement to extract some information. I plan to use this as a starting point and note of comparison of the companies. Earnings per share is a key stat that will focus the current profitability of the companies as well as the dividend, which is a direct payout to investors. To define the total return of the company, the dividend and stock price appreciation combined in relation to the current stock price will provide our analysis of the return to investors.
The mega banks have mega shares outstanding. This is important because if these companies' earnings increased by $1 million in the next quarter, it would not really make a difference in the return to investors. Here is a chart of the current stock price on the open of August 24, 2014 and the numbers of outstanding shares.
As you can see the number of outstanding shares is in the billions, except for Goldman Sachs. To Goldman Sachs, a $1 million dollar increase in profit would amount to 2-thousandth of a dollar, or ten shares would give you two cents. The amount of increase in business or interest spread would have to be large to create a noticeable difference in their financial statement from quarter to quarter. As competitive as the marketplace is, the chance for this much change is low, and we can expect these banks to follow their current business trends for 2014 and into 2015.
The earnings per share (EPS) is a good indicator of the business operations and is a fair comparison for the cost to investors.
Based on the comparison of EPS to current price, we see that Goldman Sachs has the highest EPS to current stock price. This would represent a better return for investors when looking at earnings for the cost of the investment.
A direct payout of the quarterly dividend is direct cash (or reinvestment to buy more shares) into the owner's pocket. Dividends are one half of the annual return to investors. Stock price appreciation is the other. The combination of these 2 determine the return the investor gains for the year. The dividend when compared to the stock price provides the yield in percentage of return.
Although Goldman Sachs has the highest dollar amount payout at $0.55 per quarter, the yield is only 1.3%. Wells Fargo and JPMorgan both pay a higher dividend yield. Citigroup is the lone company that has not raised their dividend since the 2008 financial crisis, and the latest delay was earlier this year when the Federal Reserve Board denied their dividend increase in the Capital Plan due to the issues with the fraud case in Mexico. Citigroup has the ability and resources to raise their dividend, and barring any extreme events will raise their dividend in 2015.
The Federal Reserve Board has been extremely hard on the banks since the financial crisis, and in some respect, rightly so. The banks were the entities that created the opportunity for many of the bad loans and the Feds have taken strong measures to prevent this from happening again. The banks are much more financially sound today than they were in the mid 2000s prior to the crisis.
The banks trade at a unique ratio to their book price. Several trade at a premium, and others at a discount.
Wells Fargo trades at a strong premium mostly because investors value the stock for its consistent earnings and business operations. The next closest is Goldman Sachs at 1.07, and JPMorgan at 1.05. Bank of America and Citigroup sell at a discount, both at 76%, which as an investor looks like an opportunity to buy in at the low price; if the companies are going to continue to earn profits and increase their book value, the stock price is likely to increase at a higher rate than the other four.
The last item I will cover is the Basel III ratio and Supplementary requirements (in 2015 may be identified as the fully phased in ratio). All six banks met the requirements in 2014 and will in 2015. Here are the current estimates based on their second quarter's financial reports.
(Goldman Sachs did not report Supplement comment in 2Q, 2014 Financial statement)
The companies will manage their cash and liquidity to ensure they met the Federal Reserve's requirement to be allowed to execute their Capital Plans for 2015. Citigroup has been repurchasing or retiring debt with the excess cash and all will have strong reporting numbers in early 2015 for the Fed's review.
The increase in interest is likely to begin in 2015, but will need a starter to push the Fed to allow the ease in rates. The housing market will have to grow on its own after October 2014, as the Federal Reserve Board plans to stop purchasing bonds on the market at that time. There are sufficient funds in the market for lending; however, the factor that is most likely to be pushing rates will be inflation. The market has held prices down for several years and may begin to allow prices to grow. This is not bad, and is a natural occurrence in the market, but should begin to push rates up in 2015. The results will be felt in the housing market as cost of borrowing money goes up. It will not stop the growth, but temper future borrowings to long term strategies for businesses. All the banks will adjust over several quarters to new rates and retain their ability to turn profits. I do not see a winner at this time, but all will be profitable over time.
- Citigroup Inc. is our pick to provide the biggest return for investors over the next 12 months.
- Bank of America is our second pick to reach a 10% return for investors.
- Goldman Sachs is our third pick, with many fewer outstanding shares any increase could reach more than 10% return for investors.
- Wells Fargo is our fourth pick and has a realistic chance to reach a double-digit return based on earnings.
- JPMorgan is our number five pick, as it will have to rebuild its financial position for the Basel III requirements next year, which will prevent any move toward returning a higher yield to investors.
- Morgan Stanley falls to the sixth place, but not last. All of the banks will have profitable quarters in 2014 and 2015. All will meet the requirements of the Federal Reserve Board's Basel III requirements, it is just Morgan Stanley has the lowest earnings per share ratio and is currently trading at book value, so we do not see the opportunity for a 10% return over the next year in stock price appreciation and dividend payout.
Here is a more detailed analysis for each company:
Citigroup Inc. has the second highest earnings per share per stock price and has the third lowest number of outstanding shares, which means the company has a better opportunity to increase earnings that will impact the return to investors. Citigroup is the only bank that has not been allowed to raise their dividend, but expectations are high for 2015. Citigroup has extra cash and has been retiring debt which will reduce the cost of paying bond interest and/or preferred shares. Citigroup is also trading at a discount, but more likely to increase its stock price more than Bank of America. It is possible for the share price to appreciate to near $55 by the end of 2015 with two more strong quarterly financial statements. This would represent an 8% stock price appreciation, closer to the 10% we look for in an investment, but this assessment is only for a 6-month period, the rest of 2014. Citigroup is also more diversified outside the U.S. that will allow for world growth to benefit the company's revenue and bottom line. The Pacific investments will be most profitable for Citigroup, it is where Citi is more heavily invested. Citigroup is a good investment for 2014 and when the dividend is increased, the stock should see another bump in stock price.
Bank of America has the second lowest earnings per share for investment dollar and has the most outstanding shares. This will make it more challenging for the stock price to increase over time. The company has increased earnings by 5% and cash flow is positive, but not enough to increase per share for 10 billion outstanding shares. The stock is trading at a discount of .76, and has the opportunity to raise its stock price toward the book value of $21.16. It is likely a gain toward $17 by the end of the year, but should continue to trade below book through 2015. If the stock climbs from its current price of $16.13 to $17 by year's end that would result in a 5% increase. BAC just raised the dividend from $0.01 to $0.05 for 2Q, 2014 and now the dividend yield is 1.2%. We do not see BAC's operations increasing to reach the 10% gain opportunity we look for in an investment.
Goldman Sachs Group Inc. has the highest rating of EPS to stock price at 9.3%. With strong growth and earnings each quarter, the investors have a good opportunity to reach a 10% return on their investment for 2014 and 2015. With only 440 million shares outstanding, compared to the billions of shares for the other 5 banks, the company is able to payout a higher dollar amount ($0.55 dividend per share), although the yield is only 1.3%. The stock is trading at a slight premium of 1.07, and at $175.47 on the open of August 26, 2014, the market is less likely to move the stock price very far. Goldman Sachs reported the second highest Basel III self-assessment at 11.4%. Goldman Sachs is most likely to provide the best return of the 6 major banks, although all should provide a positive return through 2014 and 2015.
Wells Fargo & Co. has the second most outstanding shares at 5.22 billion shares, and tied for the best dividend yield at 2.7%. Wells Fargo is trading at a premium, well above the other bank stocks at 1.65 per book value. This would indicate the stock is less likely to increase as much as those trading at a discount. Wells Fargo's earnings per share, per stock price is 7.7%, which represents a healthy profit from operations. The stock price is likely to be flat or increase slightly, giving up some of the premium over the book value. We do not see Wells Fargo increasing the stock price and dividend to reach near the 10% return in the next 6 to 12 months.
JPMorgan Chase & Co. also pays a dividend yield of 2.7%, but has a price to book value trading at a slight premium of 1.05. The EPS per price is a yield of 7.5, which is in the middle of the 6 big banks. JPM has the lowest Basel III self-assessment at the release of the 2Q financial report, although they have ample time to bring cash flow in line. JPM will continue to report profits each quarter based on growth and earnings, but lacks the ability to increase stock price and dividends near a 10% return for investors in 2014 or 2015.
Morgan Stanley has the lowest EPS to stock price ratio at 4.1% and just 1.2% dividend yield. The stock is trading near book value BV ($33.47), while the stock price opened on August 26 at $33.48. Morgan Stanley reported the highest Basel III numbers with 13.8% based on 2014 standards and 15.2% for the Tier 1 risk-based capital ratio. Morgan Stanley investors are right on book value and with strong cash flow operations, will continue to be profitable, but fall short of our goal of 10% increase in stock price and dividend return.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may consider some of these stocks in early 2015 based on returns prior to Basel III assessments.