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By Gene Kirsch

Will the 2011 carnage of domestic banking stocks continue in 2012?

The KBW Banking Index (BKX), a weighted index of 24 bank stocks that serves as a benchmark of the banking sector, lost 25% of its value in 2011. The index consists of geographically diverse stocks representing national money centers and leading regional institutions such as Bank of America (BAC) (down 58%), Citigroup (C) (down 44%) and Wells Fargo (WFC) (down 41%). It also includes the likes of SunTrust (STI) (down 40%), JPMorgan Chase (JPM) (down 22%) and those who fared much better like U.S. Bancorp (USB) (up 0.3%) and PNC Financial (PNC) (down just 5%). Even the S&P Banking Index, a much broader banking index, lost 12% of its value in 2011.

Will this continue? Are there good investing values to be found in the banking sector? First, consider the macroeconomic climate. Domestically, the economy appears to be stabilizing. Gross Domestic Product (GDP) growth has been positive for the last seven quarters, and the current unemployment rate at 8.5% is the lowest since April 2009.

Challenges still remain in the housing market and the European debt crisis' is likely to have an effect on the U.S., but low interest rates and the strong dollar should help offset those risks in the short term. Keeping borrowing costs relatively cheap for consumers and businesses should provide a boost to the banking industry through increased lending activity and improved profitability.

The table below includes publicly traded banks that may represent good investment value. Of the 1,190 publicly traded banks that are rated by Weiss Ratings, 14 meet the following criteria:

  • positive earnings per share
  • current stock price to tangible book value less than 90%
  • current stock price at least 10% off its 52-week high
  • forecasted stock price based on next year's earnings greater than its current stock price

As of January 26, KeyCorp (KEY) traded at $7.88 per share, with a book value of $9.10 at September 30, reflecting a ratio of 87%. And the bank is currently trading at a 19% discount from the 52-week high of $9.77 reached on February 15, 2011. Based on an average P/E of 11.62 and forecasted EPS of $0.89., we forecast a 12-month price target of $10.34 or an increase of 31.3%. The assumptions to arrive at the price target are fairly conservative using an 11.62 P/E compared to the historical average of 14 for all publicly traded companies, and the forecasted EPS is the average of all analysts reporting on that bank for the most recent fiscal year of 2012.

Other banks on the list offer as good or even better potential upside while most suggest an increase in the neighborhood of 20% for the year. Taking overall financial strength into consideration, the choices narrow somewhat. The highest-rated bank on the list is KeyCorp at B- ("Good"). Those with a rating in the C ("Fair") range are also considered safe and could be interesting to consider. Of course, risk takers might be willing to disregard the issue of financial strength entirely and invest based solely on the potential short-term price upswing. That opens up the whole list, including those with ratings in the D ("Weak") range.


(Click to enlarge)

Data Source: SNL Financial

1 Ratings are based on September 30, 2011 data. A=Excellent; B=Good; C=Fair; D=Weak; E=Very Weak; Plus sign=top of grade range; Minus sign=bottom of grade range

2 Book value is based on tangible book value per share price at September 30, 2011.

3 Forecast EPS is the mean (average) earnings per share for fiscal year 2012.

4 Price target is based on the average Price to Earnings Ratio (P/E) for all publicly traded banks (11.62).

Source: 14 Undervalued Bank Stocks