3 Financial Stocks Worthy Of A 'Strong Buy'

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 |  Includes: KEY, RF, SCHW
by: Takeover Analyst

What follows is a list of financial companies with various degrees of upside. They cover a variety of industries: banks, brokerage, and specialty investment service. In my view, the financial sector at large is trading heavily below intrinsic value due to an irrational perception of risk. From the financial recession to Dodd-Frank regulations, many investors are on "wait-and-see" mode in the sector. Unfortunately, this risk-averse approach to investing fails to fully exploit behavioral anomalies. There is a happy balance between testing the markets and waiting until the value gap has been closed. Financials have already delivered strong returns over the last six months, so the time to just "test the markets" has passed. An investment is recommended now before the entire value gap is closed.

Regions Financial (NYSE:RF)

Regions trades at a respective 50.5x and 8.4x past and forward earnings with a dividend yield of 0.6%. Consensus estimates for Regions' EPS forecast that it will grow by 247.1% to $0.59 in 2012 and then by 32.2% and 17.9% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $0.75, the stock would hit $8.25 for 25.8% upside.

This company may be 50% more volatile than the broader market, but execution has still been strong. During the most recent quarter, Regions delivered a solid $0.14 per diluted share. Perhaps most impressively, Regions has performed well despite a challenging regulatory environment and tough capital requirements. Asset quality meaningfully improved with inflows of non-performing loans declining by 32% sequentially.

Charles Schwab (NYSE:SCHW)

Schwab trades at a respective 19.9x and 15.5x past and forward earnings with a dividend yield of 1.8%. Consensus estimates for Schwab's EPS forecast that it will grow by 1.4% to $0.71 in 2012 and then by 19.7% and 25.9% in the following two years. Assuming a multiple of 17x and a conservative 2013 EPS of $0.82, the stock would hit $14.11 for 7.3% upside.

2011 performance showcased promising momentum. Brokerage accounts, asset, and the core business all meaningfully grew. Client assets are now trending towards $1.7B while multiples stay on reasonable levels. Schwab offers the highest dividend yield of the three companies highlighted herein - a testament to management's confidence over free cash flow.

KeyCorp (NYSE:KEY)

KeyCorp trades at a respective 8.6x and 9.6x past and forward earnings with a dividend yield of 1.5%. Consensus estimates for KeyCorp's EPS forecast that it will decline by -10.3% to $0.78 in 2012 and then grow by 5.1% and 20.7% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $0.80, the stock would hit $8.80 for 11.8% upside.

Several trends make this financial an attractive pick. First, credit quality has been improving. During the first quarter of 2012, net charge-offs fell 82 bps while average CF&A loans grew 7.2% sequentially. Second, the balance sheet is strong. In terms of regulatory headwinds, KeyCorp is relatively safe and has, accordingly, received no objection from the Federal Reserve over its 2012 capital allocation plan. Third, management remains committed to returning free cash flow to shareholders. The $344M repurchase plan and dividend hike showcase confidence over business sustainability.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.