We are increasing our exposure to the financial sector—one of the few areas of the market where I am still seeing some value—explains Bret Jensen of Investors Alley’s Blue Chip Gems.
First, let’s look at the tailwinds that should benefit all major banks over the coming quarters and years.
Rising interest rates is a critical trend that should play out over the coming years as the Federal Reserve normalizes monetary policy. This will help net interest margins, one of the biggest profit drivers at banks.
Meanwhile, legal costs are finally starting to drop across the board. Now that a pound of flesh has been extracted, banks should be able to focus more on prudently growing their loan book.
In addition, housing activity is starting to accelerate at a significant clip. This will provide an important earnings driver.
We selected Bank of America (BAC) to join our portfolio. I like that the bank does not have the international exposure of some of its peers.
In addition, Bank of America should have the fastest earnings growth of any of the major banks over the next couple of years. And the stock trades at just 10 times the top end of next year’s earnings range.
In addition—based on book value—Bank of America is undervalued compared to its brethren.
Finally, Bank of America has a dividend yield of just 1.1%, lower than the other banks. However, it also has a minuscule payout ratio of 15% of this year’s earnings.
That payout ratio should increase towards 40% to 50% in coming years as regulators are satisfied banks are meeting their new capital ratios.
With myriad positive tailwinds for banks in place, Bank of America is just the type of long-term value we try to uncover.
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