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Banking Companies Could Lend Help to your Investment Portfolio

 

Tuesday, April 19th, 2016

The financial industry has been beaten up for various reasons over the last few months.

There have been major concerns surrounding comments from certain presidential candidates regarding the breaking up the big banks, oil loans that could be potentially disastrous, and concerns of an extended period of low interest rates.

It is important to note that banks make most of their money based off what is known as net interest margin. This is the spread between the rate they borrow money and the rate they lend money. When interest rates rise this spread normally increases which is beneficial to the banks bottom line.

With all the negativity surrounding these banking stocks, analysts slashed expectations for banks and their earnings in the first quarter.

So far we have seen some of the major banks report earnings and come in well above expectations. It seems that much of the negativity surrounding these companies has been overdone, this could lead to great opportunities to find strong companies at a great value. 

In the recent conference calls from J.P. Morgan and Bank of America, their CEOs discussed the underlying strength of the current economy and their current client growth.

Although net interest margin is not expanding, they are very pleased with the number of clients they are attracting. This will be beneficial to the companies when the net interest margin does expand, because they will have a larger client base to expand upon. This will ultimately lead to higher profitability for these companies.

When applying user growth to the financial world versus the tech world you are left with a puzzling analogy.

I am talking about comparing a company like Netflix versus the banking companies. They are both growing their users at strong rates yet one trades at a high flying P/E while the banks are extremely undervalued.

Netflix has a current P/E of 340, while J.P. Morgan has a P/E of 10.55 and Bank of America has a P/E of 10.99. These three companies all discuss user growth, but the banking industry is a lot more "boring" than the high flying Netflix. Although they all discuss the excitement of user growth, does the excitement of Netflix justify a crazy multiple? 

At Wilsey Asset Management we do not believe so and are led to conclude that we want to stay away from those high flying companies and look instead at some of the potential great buys in the banking industry.

One bank that looks interesting is U.S. Bancorp (USB). This bank primarily operates in the Midwest and west regions. It is not as big as the major names like Bank of America, J.P. Morgan, and Wells Fargo, but it offers many of the same services and still operates approximately 3,100 banking offices and 4,900 ATMs.

They are expected to report earnings on April 20th, 2016. If we held this company or were considering investing in it, we would want to make sure they were also discussing similar patterns in client growth as the major banks.

As always it is important to take a look at the fundamentals of the company. The valuation ratios for USB appear slightly overvalued when comparing to the industry.

The current P/E of 13.02 is above the industry average of 9.93. Price/Revenue of 3.56 is above the industry average of 2.09. Price/Tangible Book Value is 2.14 is above the industry average of 1.18.

The company currently pays a nice dividend of 2.48%, while only using 31.83% of its earnings to pay it out. The balance sheet for financial companies is different from traditional companies as many liabilities are assets in the banking industry. USB has a very strong profit margin of 29.53%, which is well above the industry average of 21.06%.

Looking forward to December 2017, estimated earnings per share on a GAAP basis are $3.55. Applying our 16.5 multiple, we arrive at a target sell price of $58.58.

This is approximately 40% above Tuesday's close of $41.91. U.S. Bancorp appears to be a company worth further research based on the estimated return and its nice dividend. 

Do you have a question or a company you would like us to take a look at?
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