Especially during this sluggish recovery, financials offer a great way to generate abnormally high returns. The reason for this outperformance stems from the market's irrational level of risk discounting in the industry. When times are bad, behavioral anomalies can make investors myopic. From Dodd-Frank regulations (e.g. tough capital requirements, stress testing, proprietary trading bans, etc.) to business speculation, admittedly, the risks are high. However, this causes otherwise strong firms to trade well below intrinsic value. In this article, I present two companies that I think are "buys" and one that is around a "sell".
US Bancorp (USB)
US Bancorp trades at a respective 12.2x and 10.6x past and forward earnings with a dividend yield of 2.4%. Consensus estimates for the company's EPS forecast that it will grow by 13.7% to $2.74 in 2012 and then by 9.1% and 10.7% in the following two years. Assuming a multiple of 10x and a conservative 2013 EPS of $2.94, the stock would slightly fall.
Even still, the company has delivered impressive results during the first quarter. The top-line grew 9.1% as average loans fell 8.2%. Nevertheless, the stock is only as volatile as the broader market, which does not allow for the high risk-adjusted returns many value investors in financials seek. US Bancorp has already outperformed the Dow Jones and thus has limited upside from here against peers. I would thus recommend selling some shares and then buying them back at a dip.
Fifth Third Bancorp (FITB)
Fifth Third trades at a respective 9.5x and 9.4x past and forward earnings with a dividend yield of 2.3%. Consensus estimates for Fifth Third's EPS forecast that it will grow by 18.5% to $1.41 in 2012, and then by 7.1% to 15.2% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $1.45, the rough intrinsic value of the stock is $17.40.
The company had an excellent start to the year with a diluted EPS of $0.45. Excluding specialized items, this was a 9% sequential increase. Top-line results were also stronger than consensus across the mortgage, corporate banking, and advisory businesses. Better yet, market share gains will help raise confidence during this sluggish recovery. Accordingly, Fifth Third is a strong investment right now.
Morgan Stanley (MS)
Morgan Stanley trades at 6.5x forward earnings with a dividend yield of 2.4%. Consensus estimates for Morgan Stanley's EPS forecast that it will grow by 15.1% to $1.45 in 2012 and then by 68.3% and 11.9% in the following two years. Assuming a multiple of 10.5x and a conservative 2013 EPS of $2.38, the stock would surge to $24.99.
What makes this financial an attractive stock investment is that ROE and EPS have been at their highest since the financial crisis. With a Tier 1 capital ratio of 16.8%, Morgan Stanley also has very strong liquidity, which reduces its nature as a regulatory target. During the most rent quarter, Fixed Income benefited from improvements to balance sheet velocity and efficiency. Like Fifth Third, Morgan Stanley, in my view, merits opening a long position in.