Stock of the Week
AMEX Symbol: XLF
Industry: Financial ETF
Price as of 5/22/09: $11.66
The financials have broken a lot of hearts over the last two years. Investors and employees have been let down by executive teams more focused on their bonus potential then risk management and the preservation of the company. The list of large cap banks that disappeared in the last two years is staggering. Financial titans like Countrywide, Bear Stearns, Lehman Brothers, Washington Mutual, Merrill Lynch, and Wachovia either went bankrupt or merged to prevent bankruptcy. Citigroup exists to this day thanks to the government and the simple fact it's too big to fail. To a lesser extent, Bank of America can be thrown into that same category. But the fundamentals for the financials are slowly improving thanks in part to low interest rates, a big surge in refinancing, and a Spring thaw in the housing market. The release of the government's stress test results two weeks ago and two upgrades from Goldman Sachs this week have also done their part to ease tensions regarding the financials.
On Monday, Goldman Sachs added Bank of America to their conviction buy list. Their optimism was based on another solid quarter for the mortgage business and the capital markets in general. They believe Bank of America has the ability to make money again in the second quarter (25 cents a share) and earn its way out of this economic cycle. Goldman believes the financial valuation will continue to shift to discounted, normalized, and diluted earnings. Their 12-month target is only $15 a share, but the upgrade did lift the sector and the Dow by over 250 points.
Barrons ran a similar article two weeks ago regarding the valuation of financials. Back in March, investors were valuing the bank stocks at price to tangible book. Now, thanks to an economy showing signs of life, investors are scrambling to figure out normalized earnings for the big banks. Among the big cap stocks, Barrons believes JP Morgan can make over $5 a share in earnings, Wells Fargo and Bank of America $3 a share, and Citigroup only 50 cents to 90 cents a share.
On Friday, Morgan Stanley raised their price targets on the major banks. The firm raised Bank of America's target to $32 from $25, BB&T Corp to $33 from $24, Bank of New York Mellon to $43 from $31, Boston Private Financial to $9 from $6, Citigroup to $6 from $4, Fifth Third Bancorp to $14 from $10, JPMorgan to $60 from $45, KeyCorp to $10 from $9, Northern Trust to $82 from $66, PNC to $77 from $67. Morgan Stanley also raised State Street to $59 from $36, U.S Bancorp to $30 from $22, ans Wells Fargo to $44 from $33. Morgan Stanley sees most U.S. banks repaying TARP by the fourth quarter this year and expects a number of them to repay TARP in the third quarter. That's very bullish, yet the financials did not react to the news.
Picking individual bank stocks has been very dangerous. The biggest bank failure this year occurred Thursday down in Florida. The more diversified way to invest in the financials is through an ETF index like the XLF. For aggressive investors, there are leveraged ETF funds like the Proshares and Direxion funds that return two to three times the XLF returns. Although as investors have found out, they also produce two to three times the downside as well.
The financials have been an awful place to invest money. But they will survive and produce strong gains once the economy rebounds.