3 Bank Stock Bargains for Income and Gains

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Since last April, shares of bank stocks have lagged the market indexes. As we speak, the KBW bank index is languishing more than 20% below its 2010 peak. What’s ailing bank stocks? Here’s just a sampling:

The U.S. economic recovery is proceeding slowly and haltingly, keeping the industry’s loan losses unusually high; new government regulations associated with the Dodd-Frank financial “reform” will cost banks dearly, perhaps $20 billion a year or more; some of the industry’s big players have even managed to shoot themselves in the foot again by ramming foreclosures through the legal system without adequate paperwork.

If all this muck has you throwing up your hands in disgust, I understand. I certainly hold no brief for crooked or incompetent bankers. On the other hand, nearly four decades of investment experience has taught me that when an entire industry is as disliked as banking is now, there are bargains to be had.

Here are three bank stocks I’m recommending to my Profitable Investing readers. Not only should they handily beat the market over the next 12 months, one may soon raise its dividend 400% to 500%.

Bank Stock #1 – FNFG

The first bank stock is a regional gem headquartered in Buffalo, N.Y. While other banks were plunging into subprime mortgages a few years back, First Niagara Financial Group Inc.(NASDAQ: FNFG) stuck to its credit standards. As an added precaution, CEO John Koelmel maintained huge amounts of excess capital on the bank’s balance sheet — a stance that paid off handsomely when the global financial crisis struck in 2008.

FNFG was in a perfect position to take advantage of the turmoil by gobbling up assets other banks were forced to sell. In 2009, First Niagara acquired Harleysville National, a Pennsylvania bank, as well as 57 western Pennsylvania branches of Cleveland’s National City Corp. Both transactions immediately boosted FNFG’s earnings per share. More recently, in August 2010, FNFG inked a deal to take over NewAlliance Bancshares, a healthy Connecticut banking chain.

Result: FNFG will have grown from $8 billion in assets to $30 billion in just three years, while paying one-third to one-half the price (in terms of book value) that managements gleefully paid during the heyday for bank takeovers in the late 1990s. First Niagara hasn’t compromised its strong credit quality, either. Nonperforming loans at June 30 equaled only 0.74% of the total loan portfolio — versus 5.36% for all banks nationally. Unlike many banks, too, FNFG has continued to pay its dividend at the full pre-crisis rate. Its current yield is 4.9%.

What to do now: At 12X estimated year-ahead earnings, I figure the stock has room to generate a total return of 15%-20% in the next 12 months. Buy FNFG at $12 or less.

Bank Stocks #2, #3 – JPM, BK

Niagara is my pick for conservative investors who want a hearty dividend up front. If you’re more focused on capital gains, though, a couple of the nation’s biggest banks may serve you a rich banquet over the next six to 12 months.

At the moment, the investment community is (rightfully) skeptical that the megabanks will be able to surmount their problems anytime soon. However, I think a catalyst is emerging that will help dissolve at least some of these doubts.

In January, the giant banks will report their year-end results. For several companies, the earnings trend should prove strong enough to let the board of directors declare a sharply higher quarterly dividend. (Recall that in the aftermath of the crisis, federal regulators pressured nearly all the largest banks to slash their payouts to the bone.) If the dividend increases are as sizable as I expect them to be, investors will likely respond with a collective whoop.

My top candidates for an early dividend hike are JPMorgan Chase & Co.(NYSE: JPM) and The Bank of New York Mellon Corporation(NYSE: BK), in that order.

At an investment conference in September, Morgan CEO Jamie Dimon openly speculated that his bank could raise its dividend during the first part of 2011. How much could JPM pay? If we assume a modest one-third of estimated 2010 earnings, the annual rate would zoom to $1.20 per share — a 500% increase from the current 20 cents.

Morgan’s solid Q3 earnings, announced Oct. 13, bolster my confidence that the bank can, in fact, afford a large dividend hike soon. Profits came in 23% above the same period last year, and 12% above the analyst consensus.

BK never reduced its payout as much as JPM did. Thus, there’s less ground to make up. Currently, Bank of New York is dishing out 36 cents per share annually (down from 96 cents before the cut in April 2009). Assuming roughly a 30% payout ratio on this year’s estimated earnings, I reckon that BK could lift its dividend to an annual rate of 70 cents in 2011.

For Morgan, my projected dividend would work out to a yield of 3.2% at today’s share price; for Bank of New York, the yield would stand at 2.7%. In either case, you’ll earn a good deal more than on a money market fund — and if the market interprets the dividend news the way I foresee, you’ll pocket some nifty appreciation as well.

What to do now: Buy JPM at $45 or less and BK at $29 or less. From here, I’m targeting a 20%-30% return for both stocks in the year ahead.


Article printed from InvestorPlace Media, https://investorplace.com/2010/10/bank-stocks-to-buy-fnfg-jpm-bk/.

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