By Philip van Doorn
Investors face a rare binary moment and a possible opportunity to make a lot of money by investing in bank stocks ahead of the herd.
The big question is, do you believe the new coronavirus vaccines will be effective when they are deployed, and that the pandemic will end over the next two years?
Wall Street analysts have plenty of “buy” ratings on bank stocks. But they are forced to stick with 12-month price targets, which may be too short a time frame. This may well be your golden opportunity to get ahead of the street with a longer-term recovery play.
BioNTech SE /zigman2/quotes/214419716/composite BNTX -1.61% and Pfizer Inc. /zigman2/quotes/202877789/composite PFE +0.21% began the party last week, saying their COVID-19 vaccine was 90% effective in a Phase 3 trial. Then Moderna Inc. /zigman2/quotes/205619834/composite MRNA +2.48% did them one better , saying its coronavirus vaccine was 94.5% effective in a late-stage trial, and that the vaccine could be stored for longer at standard refrigeration temperatures.
Take a look at this chart, showing the performance of the KBW Bank Index /zigman2/quotes/210598427/realtime BKX -2.67% against the S&P 500 Index /zigman2/quotes/210599714/realtime SPX -2.45% this year:
The broader market has recovered beautifully from the March doldrums, and is up nicely for 2020. But the KBW Bank Index is still down 20% this year. Bank earnings took a blow during the first and second quarters as they beefed up their loan loss reserves. But this changed during the third quarter, as loan losses didn’t rise as expected . The unprecedented support for consumers and businesses by the federal government and the Federal Reserve’s multiple moves to lower interest rates were working.
But after the good third-quarter results came in, investors continued to expect a pike in loan losses in the fourth quarter or the first quarter of 2021.
Does all that change now that we have such good news about vaccines? You need to decide that for yourself. If you are a believer, the banks look cheap and should be bought.
One easy way to go in would be to buy shares of the Invesco KBW Bank ETF /zigman2/quotes/202716924/composite KBWB -2.80% . It holds all 24 stocks in the KBW Bank Index. But you might also consider individual bank stocks.
We’re going to list the 24 stocks in the KBW Bank Index, sorting them in various ways, while adding two large investment banks to the group: Goldman Sachs Group Inc. /zigman2/quotes/209237603/composite GS -0.87% and Morgan Stanley /zigman2/quotes/209104354/composite MS -1.82% .
Here are all 24 stocks sorted by current price-to-tangible-book ratio. A bank’s tangible book value excludes intangible assets, such as goodwill (the carrying value of premiums paid for acquisitions) and loan servicing rights. The table is sorted by ascending values, and you can see these values have gone down dramatically for many of the banks this year:
Citigroup Inc. /zigman2/quotes/207741460/composite C -1.73% is typically the cheapest of the large bank stocks relative to book value, especially during a time of economic stress. But the pandemic — as horrible as it is — isn’t anywhere near as threatening to the big banks (or their investors) as the 2008-2009 credit crisis. Credit quality has held up well and the banks’ capital levels are much higher than they were at the end of 2007.
Among the banks listed here, only two have cut dividends during the pandemic: Wells Fargo & Co. /zigman2/quotes/203790192/composite WFC -1.91% lowered its quarterly dividend to 10 cents a share from 51 cents, and Capital One Financial Corp. /zigman2/quotes/204480509/composite COF -4.21% reduced its quarterly payout to 10 cents from 40 cents.
In such a low interest-rate environment, an attractive dividend yield can make it much easier to wait for the banks’ stock prices to recover — again, assuming you are a believer in the new vaccines and a steady path for economic growth over the next two years.
Here are the 26 bank stocks sorted by dividend yield:
This time we’re sorting the list two ways: First by percentage of “buy” or equivalent ratings among analysts polled by FactSet. Half of the group has 50% or more “buy” ratings. Then that group and the group of remaining banks is each sorted by the 12-month upside potential implied by the consensus price targets:
It’s clear that Wall Street’s 12-month time frame is not long enough to predict strong gains for all the bank stocks that are loved by analysts, or even to have price targets that are “in line” with the ratings.
Citigroup has 81% “buy” ratings and the consensus price target implies a 26% gain over the next 12 months (while investors collect that attractive dividend). That goes along with its price-to-tangible-book ratio and dividend yield exceeding 4%. But 87% of the analysts have favorable ratings for First Horizon National Corp., with a price target only 6% higher than the current price.
Then there are stocks that are out of favor, such as Wells Fargo, whose consensus price target is 21% higher than the current price. The custody banks, State Street Corp. /zigman2/quotes/209758976/composite STT -3.33% and Bank of New York Mellon Corp. /zigman2/quotes/200171276/composite BK -1.90% , also have minority “buy” ratings, but price targets showing decent gains expected overt the next 12 months.
But one year is actually a short period for a long-term investor. If you have conviction about the direction of the economy and do your own research to feel comfortable with one or more of these banks, this is the time to buy.