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Throughout all of 2011, investors who were heavily exposed to financial stocks were stunned by the level of disappointment through which they have had to endure. If you are a regular investor like me, you shouldn’t feel so bad, because remarkably even those with longer investing resumes were made fools of by several bank executives who simply could not live up to the expectations. According to a Bloomberg survey, last year a poll of bank analysts predicted that profits at the biggest banks would increase by 32% in 2011. Not only were those projections missed entirely, but financials as a whole was the worst performing sector in all of 2011 as indicated by the chart below.

Click to enlarge

S&P500 Sector Performance.PNG

So far in 2012, it seems that there is even more optimism as analysts expect bank profits to rise 57% - this according to yet another survey by Bloomberg. The question is will the second time be the charm or will investors be left foolish and holding the proverbial “bag” yet again? There are many banks within the sector that have been perceived as villains if not unforgiving predators - many of which have become so hated that they have been left for dead. But as many investors are quickly defecting to other sectors, could there be an opportunity or two that might become overlooked?

Last week’s stock rally (in part) was attributable to several bank stocks – to the extent that it has left many investors second-guessing their decisions to avoid financials altogether. As of last Thursday, upon the market yielding its third consecutive day of gains that were led by banks, many investors considered it might be time to start revisiting the idea that (just maybe) banks can prosper this year.

With similar optimism laid out at the onset of 2011 to only see the financial sector lose 20% on the year, could this new optimism become a case of “fool me twice?” Let’s take a look at a few banks and see if they are worthy of a second chance.

Bank of America (NYSE:BAC)

One would have to look back to 2009 to see when Bank of America was trading this low. This is even after it has gained an impressive 11% during the first trading week of the year. It is way too early to say that the bank is back on track merely on a slight uptick, but one has to wonder what lies in store after a double digit jump. I’ve discussed quite extensively the state of affairs of company – one where it has acquired an image that it is working hard to shed. It has also become the recipient of many sell recommendations. Although I would not advocate buying the company just yet, I am leery of what would be the benefit of selling it at this point.

The stock has already been beaten to a pulp and with its “too big to fail” distinction, it is not going to bankruptcy court any time soon. So if is in anyone’s portfolio, it would be a hold because the premium potential far outweighs the downside risk at this point. What is Bank of America worth? This question will undoubtedly be answered, but it will take several more quarters of operational results for anyone to get an accurate pulse of where it’s going. The company needs to be able to prove that it can run its business effectively enough to become a buy at any level.

To its credit, it has started to do what I consider a decent job to resolve its issues. But it has a lot of work to do before it turns the corner. As those issues get resolved, the earnings of the core business will start to grab the attention of many investors who have left it for dead. However, by the mere fact that it was able to stay above that all important $5.00 threshold to the extent that it even surged during the first week of trading of the New Year, it is showing that it still has life.

Citigroup (NYSE:C)

In 2011 if you were an investor in Citigroup, I think it is fair to say you went through many trying moments. While the company is working to repair its brand, its main issue continues to be with what is perceived to be a lack of strategic direction. It seems not only has the company been unable to communicate its approach, but is has also been unable to remove all of the uncertainty. Many of which have caused several investors to abandon the stock.

One such uncertainty has had to do with the company opting to keep the retail partner cards business – one that I once thought that it would dispose of. But it appeared it realized that it did not immediately need the capital that the sale would generate. But now it is betting that it will become a profitable business in the future. Having said that, its recent restructuring has proven to be more trouble than it was worth – one that has cost it valuable assets and it seems more change will occur.

As with Bank of America, the question for Citigroup is where is the value? Investors have been asking this question for all of 2011. But assuming the bank continues to restructure and executes its business without any significant drawbacks, I have to think that the company can recapture double-digit percentages of return on equity. This would make the stock significantly undervalued by at least 20% and make it a buy at current levels.

Wells Fargo (NYSE:WFC)

The motto for Wells Fargo is “together we’ll go far.” I think in 2012 it has a chance to make true on that slogan. I can't help but look at the company and see what a bargain it is. As with other banks it still has a lot of work to do to clean up its balance sheet. And one has to consider that its acquisition of Wachovia will take some time to fully integrate. Nevertheless, at $28, Wells Fargo is clearly trading considerably below if true potential.

Though its recent earnings announcement was somewhat of a disappointment, the bank should have no problems producing decent returns on equity – I would project 10% to 15%. As with Citigroup, this potential makes it a compelling long-term buy at current prices. With the volatile nature of all bank stocks, it is one that should be considered by patient investors with realistic holding timeframes.

JP Morgan Chase (NYSE:JPM)

If bank stocks were considered evil in 2011, JP Morgan Chase has always had the distinction of being the lesser of the sector’s evils – particularly because of how it managed its credit exposure during the housing bubble. Remarkably, in spite of that fact the stock lost 20% of its value last year. The company will report earnings before the market opens this Friday and many investors are hoping for the best.

The current share price inspires little confidence that the bank will be able to produce significant returns on equity. But considering the strong level of its management I am inclined to think that the company should be able to leverage its current market advantage and strong brand. As with its peers above, the opportunity for JPMorgan lies in its ability to produce better than a decent return on equity – the low to mid teen’s percentage range. This is where value investors who are willing to show some patience can be rewarded.

Goldman Sachs (NYSE:GS)

It’s hard to imagine another company on Wall Street that is loathed more than investment bank giant Goldman Sachs. This has made the company one of the more polarizing brands and stocks on the market. But when I look at the fact that it is now trading under $100, I can’t help but drool at how incredibly cheap it is. But I also say this with some trepidation knowing that the it has a lot of work left to do to restore confidence in its brand – and that’s the case for the entire sector as a whole.

Fellow Seeking Alpha contributor Stock Croc offered what I thought was an excellent bearish case for the stock. In a recent article, he said the following:

  • Overall Goldman Sachs does not stack up well when compared with its competitors. It currently has a forward P/E of 7.5, which compares favorably against JPMorgan’s 7 and Morgan Stanley’s 8. However its return on equity of 8% is less than JPMorgan’s 11% and Morgan Stanley’s 8.7%.
  • Goldman Sachs, despite reducing its long-term debt in the third quarter 2011, does not have a particularly strong balance sheet with a high debt-to-equity ratio of 3.3. This does not bode well for price stability or the company’s future earnings if we were to see a double-dip recession eventuate or further economic headwinds from a prolonged European debt crisis or Chinese property bubble collapse.

Those are indeed extremely valid points. But I sense that these metrics are virtually interchangeable within the entire sector. And honestly, when a stock has become as cheap and beaten up as it had, all of the bearish metrics become virtually known and priced in. Not to mention that as the stock sits at $93 it is trading at a considerable discount to its book value. To me, the stock is a buy at current levels and would place a $150 - $200 price target on it over the next two to three years.

Source: 5 Bank Stocks To Consider Adding To Your Portfolio In Q1