Fear and opportunity often go hand in hand. Right now there is fear in the financial sector, but where is the opportunity?
Many banks are selling at apparently attractive price to book ratios. The challenge we face as investors is making sure that the potential reward meaningfully outweighs the risk. Thankfully the fear of investing in financial stocks has invited investors to shoot everyone in this sector without regards to the dramatic differences the business models and risk profiles that these companies have from one another. This spells opportunity.
First, it is important to be clear that the two biggest risks among financial companies remain the mortgage crisis of the past few years and the PIGS. Greece obviously needs to have its debt restructured and it wouldn’t surprise me the EU straining under the weight of reviving Portugal, Spain, Ireland, and Italy as well. Obviously there is a lot of risk for the European banks and for those financial institutions with exposure to this debt crisis through derivatives. Yet, if we look away from those institutions which have tremendous exposure to this risk we find remarkable investment opportunities.
Here are two suggestions:
TD Bank (NYSE:TD) makes money the old fashioned way. For a large institution TD is a rather vanilla bank. I mean that as a compliment. While TD has rightly won appropriate praise for its risk management a neglected aspect of their franchise is their ability to generate meaningful organic deposit growth and to do so at a low cost. As central banks have been making capital available essentially for free, analysts and investors have been ignoring the importance of low cost deposit generation. Once interest rates begin to rise, investors will again award premiums to those banks which are able to collect low cost deposits. In this regard, TD has one of the best business models in banking. I also believe that the purchase of Chrysler Financial will turn out to be, if not a home run, at least a solid double for TD. Chrysler Financial gives TD a way to loan its low cost deposits at good rates in a relatively low risk part of banking.
MetLife (NYSE:MET) also appears to be an outstanding long term investment at current prices. It is amazing to see such a high quality insurance company selling for less than 90% of book value and seven times forward earnings. The only thing that needs to happen for MET to produce excellent returns over the next five to ten years is nothing. That is, the company is being priced as though something really bad is going to happen. Of course, bad things do happen sometimes as that is the nature of selling insurance. Nevertheless MET is well diversified and competently managed. I am optimistic about the integration of ALICO into MET and believe that MET will be able to generate profitable growth in Latin America and in Asia for many years to come. Over the next five years I anticipate that MET will grow earnings per share between 11 and 13% per year and that its p/e will expand from seven to twelve. If I am correct, MET will triple in value in five years. This is an excellent potential return given the relatively low risk profile of the company.
I am long both TD and MET at the time of writing this article.
Disclosure: I am long TD, MET.