Bullish on Financials

It’s been a tough year to like financial stocks. When the Fed is engaged in an interest rate hiking cycle, the financials tread water at best. I’d be willing to bet that I have sacrificed several percentage points of performance so far this year from holding a decent chunk of them.

That’s the short-term view though, and the longer term view is the one I can’t help but focus on. There are some great financial services companies out there and the valuations are way too low, below the market’s 16 P/E in most cases. Over the next few weeks and months, they might continue to flounder, but if you look out 2 or 3 years these stocks are going to make people a lot of money, and they often pay huge dividends to boot.

Excuse me for keeping many specific names closely held (after all – this is a free site, as opposed to my paying clients) but I have written about Capital One (COF) on this blog before. That story remains very bullish and the stock trades at less than 10 times forward earnings.

Another one I have yet to mention is E*Trade (ET). Most people think of them purely as a discount brokerage, but they have branched out and now offer banking and lending services as well. In fact, only about a quarter of their revenue is generated from stock commissions. The shares sell for $12 each and trade at only 11 times 2006 earnings.

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8 Thoughts on “Bullish on Financials

  1. Rick on June 2, 2005 at 1:01 AM said:

    Any idea why Capital One is paying Money Market rates that are extremely aggressive (I think I saw their online ad for 3.15%)?

  2. SiamTwin on June 2, 2005 at 7:06 AM said:

    Financials, especially banks, have always traded at below-market multiples. Is there any reason you see why their multiple should expand to reach the market’s? Or, alternatively, should we expect the market multiple to contract to meet the financials?

  3. Chad Brand on June 2, 2005 at 7:18 AM said:

    Capital One has been expanding their service offerings in recent years. Once solely a credit card company, they are now becoming a one-stop shop consumer finance company. Their purchase of Hibernia Bank will expand their distribution capabilities even further. As a result, savings rates that compete with the likes of low-cost providers such as ING Direct is not surprising.

  4. Chad Brand on June 2, 2005 at 7:22 AM said:

    As far as the P/E’s of financial stocks, I never said that they all will see their multiples reach the market’s P/E. You’re right that banks traditionally trade below a market P/E, and you will continue to see the likes of JP Morgan Chase, Citigroup, and Bank of America trade below market valuations.

    However, there are many other types of financial services companies that aren’t large banks that trade at higher valuations, usually because they are smaller, have more growth potential, and grow at much faster rates than JPM, C, and BAC.

    In addition, a company trading at 10 or 11 times doesn’t have to get up to a 16 P/E for investors to make a lot of money, especially if they are growing at double digit rates annually. A 10% growth rate per year, coupled with a P/E that jumps from 10x to 12x will net investors a 30% return.

  5. SiamTwin on June 2, 2005 at 11:21 AM said:

    One thing I’m concerned about with financials is that they currently make up more than 20% of the S&P 500, up substantially over the past decade. If you include the portions of conglomerates like GE, GM, etc. that are devoted to financial activities, you probably get a % closer to 25%. Given that a high % of institutional $ closely tracks the S&P 500 (either overtly or covertly), it seems to me that the sector is currently “fully owned” and that the prospect of lagging performace due to the flattening yield curve could see the sector de-weighted as funds sell financials to reinvest in better performing sectors.

  6. Chad Brand on June 2, 2005 at 11:36 AM said:

    If you are indexing, I can see that one might feel too overweight the sector given that many financing divisions of non-financial companies (such as GE and GM) are not accounted for in that calculation.

    However, I am looking at the sector from a stock-picking perspective, not as an index. The reason why you have seen financials grow to 21% of the S&P 500 is due to their tremendous growth. Growth companies in the sector should continue to flourish, regardless of their allocation.

    The flattened yield curve is surely a concern, but that can be solved by looking at companies who won’t be adversely affected by that.

  7. Jack Miller on June 2, 2005 at 4:40 PM said:

    Note that AMZN is building a credit card business and PayPal continues to grow by leaps and bonds. Millions of advertisers and bloggers are depositing and withdrawing money from Google accounts!

    What regulations or problems will prevent Google or Yahoo from offering more internet bank services?

  8. Chad Brand on June 2, 2005 at 5:07 PM said:

    Given that every other retailer has its own credit card, the fact that Amazon is doing the same thing isn’t very surprising. As is the case with all retail store cards, the interest rates are higher than the average card, so I don’t see them as a huge threat.

    Google’s entire business revolves around search. Their future endeavors will use search in different ways, i.e. desktop search, an OS perhaps, maps, email ads, etc. Starting an online bank doesn’t fit into their strategy at all, not with search and not with online advertising.

    As for Yahoo, I think they probably learned from eBay’s misfortune. If you recall, eBay first tried to compete with PayPal by creating its own “Billpoint” online payment service. It did horribly, even though the goods that needed to be paid for were won via eBay’s own auctions. eBay gave up, closed down Billpoint, and bought PayPal.

    All in all, none of these companies should present a problem for Capital One, who gets its customers via direct mail, and in the near future, through its bank branches.

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