Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) purchased $13 billion in bank stocks during the third quarter, including $4 billion worth of shares of JPMorgan Chase (JPM, Financial) and $6 billion worth of shares of Bank of America (BAC, Financial).
Despite enviable earnings growth and profits, the overall group, as measured by the KBW index, is down 8% for the year. Citigroup (C, Financial) and Wells Fargo (WFC, Financial) are both off approximately 15%; Goldman Sachs (GS, Financial), the worst performer of the group, is down 25%. Despite robust earnings growth, according to Barclays analyst Jason Goldberg, many large banks carry an average forward price-earnings ratio of only 10.2, against a forward price-earnings ratio of 12.6 at the start of the year.
Concerns about a slowdown in global growth and slower loan growth has kept the group depressed this year relative to the market as a whole. Additionally, for many, the banking sector still is held in low repute by those who were affected by the calamitous 2008 financial crisis.
Due to the disfavor in which the banking sector has been held by the market, Buffett sees an opportunity based on their current multiples relative to the market as a whole, their potential earnings growth and a margin of safety provided by the banks much improved capital reserve positions.
Some of the largest banks in the sector, Bank of America, Citigroup, JPMorgan Chase, Goldman Sachs, Morgan Stanley (MS, Financial) and Wells Fargo, are currently trading at only 8 to 11 times projected 2018 earnings, versus 17 for the S&P 500 index. Wells Fargo banking analyst Mike Mayo predicts earnings growth of 50% or more for JPMorgan as well as Bank of America for the next four years. While this projection may be overly optimistic, some of the individual stocks in the group are standouts.
American Express (AXP, Financial), one of the picks favored by Buffett, has had a one-year net change of 16.47% and a year-to-date increase of 9.6%; the S&P 500 by comparison has had a one-year net change of 2.54%. It’s easy to see why Buffett views this particular issue as a good bargain. American Express has been a long-term holding for Berkshire.
One particular stock that has good fundamentals and an attractive price is JPMorgan. It sells at a slight premium to the group as a whole with a price-earnings ratio of 11.5, but below the market multiple of 16, and it carries a current yield of 3%.
Two of the banks in the sector are exceptionally attractive undervalued candidates. Citigroup, currently selling at $61, trades below its tangible book value. Goldman, at $189, sells for slightly more than its book value of $186 per share.
Those who follow Buffett, but don’t wish to purchase individual shares, can participate in the anticipated prospective growth of the banking sector by purchasing an exchange-traded fund that provides broad exposure to the financial group. ETFs like Invesco KBW Bank (KBWB) as well the broader Financial Select Sector SPDR (XLF). Seven of XLF’s top 10 stocks are banks.
One of the reasons other investor’s may not share Buffett’s enthusiasm for banks is that the guru's investment strategy, to some extent, depends on whether the bull market is running out of steam, whether the economy can continue to maintain its current pace of 3%-plus growth and the likely direction of the yield curve.
Though astute investors are wont to question the "Oracle of Omaha," the fund’s holdings represent an exceptionally large position with concomitant risks should any one of several factors supporting the undervalued strategy change dramatically.
Buffett has taken a big bet with the Banks. The seven big banks held by the fund, as well its long-term holdings in American Express and other smaller banks, gives Berkshire an $85 billion stake in the sector. They account for 40% of Berkshire’s total stock holdings of $200 billion.
Disclosure: I have no positions in any of the securities referenced in this article.
Read more here:
