(08/08/14) Turnaround Expert Bets on Big Banks

Big banks were some of the biggest losers—both in terms of stock price and reputation—in the financial crisis of 2008-09, with many having to take handouts from the government in order to stay in business, recalls George Putnam, editor of The Turnaround Letter.

We believe that the bank stocks look quite attractive now for a number of reasons. The recovery in the economy in general and the real estate market in particular have significantly reduced non-performing loans at most banks.

Regulators are still restricting dividends and stock buybacks at many banks, which means that the banks are building up cash as their businesses improve, and that cash could be used to reward shareholders when the regulatory constraints are finally lifted.

Moreover, when interest rates eventually rise, that will fatten the profit margins on the lending business.

Despite all of these positives, bank stocks trade at an average price-to-earnings ratio of about 12 compared to 16 for the rest of the market. And price-to-book ratios are still quite low by historical standards.

While the banks do still face headwinds such as ongoing litigation, increased regulation, and reduced trading profits, these have been so heavily trumpeted in the financial headlines that bank stock prices have over-reacted on the downside.

As investors become aware that these negatives are more than outweighed by the good things going on, bank stocks should snap back nicely.

Bank of America (BAC) is still seen by many as a poster child for the financial meltdown, mostly because it purchased a huge mortgage company and a huge investment bank at a very inopportune time.

While the company remains the subject of negative headlines, there are signs that its various pieces—including the untimely purchases—may be beginning to hit on all cylinders again.

If Bank of America suffered the most reputational damage from the crisis, Citigroup (C) had to be a close second, and both are still suffering from more regulatory strictures than most of their peers.

But with its massive global reach, Citi has huge potential, and the new management team appears to be taking many of the right steps to slim the bank down so that it can realize that potential.

Wells Fargo & Company (WFC) emerged from the financial downturn as one of the nation’s largest and strongest financial institutions. Its rescue of the failing Wachovia during the depths of the crisis boosted Wells’ presence in wealth and asset management.

Wells’ strength is demonstrated by the fact that it is one of the few major banks that pays out more in annualized dividends today than it did before the crisis. The stock has done well over the last few years, but still looks pretty cheap to us.