Three regional banks, Bank of the Ozarks Inc. (OZRK, Financial), Prosperity Bancshares Inc. (PB, Financial)Â Â and Signature Bank (SBNY, Financial), have high predictability and trade below their 10-year median price-earnings ratio. With high profitability and strong upside potential, these companies offer strong value potential in the short term.
Regional US banks have high number of undervalued companies based on P/E (ttm)
As discussed in a previous article, the P/E ratio is likely the most commonly used valuation ratio. There are four different variations of the P/E ratio: the trailing 12-month P/E ratio, the P/E ratio without nonrecurring items, the forward P/E ratio and the Shiller P/E ratio. The P/E (ttm) measures the company’s stock price relative to the company’s trailing 12-month earnings per share.
To determine which stocks are undervalued, the statistical study compares the current share price to the product of the historical median P/E (ttm) and the current EPS (ttm). The distribution of the number of undervalued companies trading on the New York Stock Exchange and the Nasdaq is moderately right-skewed with a mean of 7, a median of 5 and a standard deviation of 11.77.
| Number of Undervalued Companies by Industry: Five Number Summary | |
| Min | 0 |
| Q1 | 2 |
| Med | 5 |
| Q3 | 9 |
| Max | 131 |
While 75% of industries have nine or fewer undervalued companies, the regional U.S. bank industry has 131 undervalued companies. Six of these companies have at least a two-star predictability rank, one of several criteria for the Peter Lynch Growth screener. The “Undervalued Predictable U.S. Banks” screener further limits the companies to three-star companies. As of Oct. 20, only three regional banks made the screener list, including Prosperity Bank and Signature Bank.
Prosperity Bank is currently undervalued based on its Peter Lynch Chart. As discussed in a GuruFocus article, Peter Lynch’s valuation chart compares the company’s stock price line to its earnings line, which represents the company’s valuation based on a P/E ratio of 15. The company is undervalued when the price line is below the earnings line and overvalued when the price line is above the earnings line. The legendary investor’s strategy is relatively simple: invest in growth companies that trade below the earnings line.
Prosperity Bank’s stock price steadily declined during late 2014 to early 2015, dropping the stock price below the company’s earnings line. The company is also undervalued based on its projected free-cash-flow.
Two regional banks have strong profitability
Prosperity Bank has a five-star predictability rank on watch, suggesting that the company’s earnings are less predictable than expected. The company’s per-share revenue has declined in the past year, and its asset growth is faster than its revenue growth. The latter implies inefficient business management.
Unlike Prosperity Bank, Signature Bank has a pristine five-star predictability rank: the New York bank has consistent per-share revenue growth and EBITDA per share growth. Additionally, Signature Bank’s operating margin, net margin and return on assets are near a 10-year high.
Among the three regional banks, Bank of the Ozarks likely has the strongest profitability. As discussed in its third-quarter earnings report, the Little Rock regional bank had a record-breaking net income of $76 million for the third quarter of 2016, a 64.8% increase from the corresponding 2015 figure. The company’s diluted earnings per share climbed 26.9%.
CEO George Gleason discussed the company’s strong third quarter performance: the acquisitions of Community & Southern Holdings and C1 Financial strategically benefited the regional bank, resulting in increased shareholder value through higher tangible book values and earnings. Strong organic growth and pristine asset quality likely resulted in strong third-quarter earnings.
Even though the company’s predictability rank is just 4.5 stars, the company’s profit margins and returns on assets outperform nearly 90% of regional U.S. banks. Additionally, the company’s operating margin and net margin are near a 10-year high.
See also
You can view all guru trades within the financial services sector using “Sector Picks.” Several gurus, including Steven Romick (Trades, Portfolio) and the T Rowe Price Equity Income Fund (Trades, Portfolio), have invested in regional banks, as discussed in previous articles. Romick expanded his financial empire with Ally Financial Inc. (ALLY, Financial) and Legg Mason Inc. (LM, Financial) while the Price Income Fund purchased over 9 million shares of KeyCorp (KEY, Financial).
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Disclosure: The author has no position in the stocks mentioned in this article.
