For the first time since last December, financial stocks are leading the vanguard as the broad market tries to rally out of its multi-month sell-off.
Bank stocks have been the sector everyone loves to hate because they were seen as the villains of the housing bubble and financial crisis. They had the audacity to continue massive bonus plans in spite of taxpayer-funded assistance.
And their future profitability was in doubt in the wake of stiff new regulation courtesy of Dodd-Frank legislation, stringent new Basel III global capital requirements, questions over their accounting practices, “too big to fail” capital surcharges, and a lack of new loan demand.
However, investors now realize that the bad news has been priced in. Loan growth is about to re-accelerate thanks to the Fed’s stealth stimulus of negative real interest rates, easing credit standards, and a steep yield curve. Loan losses are diminishing. New reserve requirements, to be phased in gradually, won’t require another round of capital raising. And valuations are now very, very attractive.
Let’s put it bluntly –- bank stocks are stupid cheap.
In fact, according to Ken Zerbe at Morgan Stanley, they only way you can justify current pricing (around 1.3 times book value) is if “you believe they will record negative earnings growth into perpetuity.” To be exact, current pricing implies a -4.8% long-term earnings growth rate.
This insight comes courtesy of the formula behind the price-to-book value calculation, which is return on equity less long-term growth divided by cost of equity less long-term growth.
Zerbe plugged in the following numbers to come to his conclusion: 11.2% group return on equity (his 2013 estimate, already well below the 15.3% pre-crisis average) and a 7.7% cost of equity (pre-crisis levels, despite stronger capital levels and less income statement volatility).
The negative 4.8% implied long-term growth rate is well below the positive 3.6% growth rate seen between 1990 and 2007.
As a result, Zerbe sees great value in the sector — particularly in mid-cap bank stocks like my top stock for 2011 pick Zions Bancorp (NASDAQ: ZION). Other picks include Texas Capital Bancshares (NASDAQ: TCBI) and Cathy General Bancorp (NASDAQ: CATY) — both of which I’ve recommended to my newsletter subscribers.
Disclosure: Anthony has recommended CATY and TCBI to his newsletter subscribers.
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The author can be contacted at anthony@edgeletter.com. Feel free to comment below.
