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Published: July 26, 2010
Big banks have huge upside.
On July 12, I told you it was time to buy financials. I think
the opportunity is even more compelling today. I'll show you why
in a minute. But first, let's go over the basic case for Big
Finance...
The Federal Reserve is keeping interest rates at zero for at
least the next 18 months. That means banks can borrow for next
to nothing and lend at much higher rates.
Also, almost every institutional analyst lowered earnings
estimates heading into the current quarter. That might sound
bad, but it means expectations for this sector are low. It makes
an upside surprise more likely.
And bank earnings are headed for a boost. All-time-low mortgage
rates will spur a wave of refinancing. And high cash levels
combined with lower stock prices will heat up the merger and
acquisition (M&A) market. M&A generates big profits for banks
who act as middlemen.
Plus, financials are one of the hardest-hit sectors. Over the
past four months, the Financials Select Fund (NYSE: XLF)
lost -15%.
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Even with all this working in the big banks' favor, you may
still think I'm crazy to buy here. After all, the financial
reform bill (which was signed into law last week) is designed to
prevent banks from being "too big to fail." Shouldn't all that
new regulation limit growth and prevent the biggest banks from
reaping the kind of profits they saw before the crash?
Well, judging by a few stats I found recently, nothing could be
further from the truth...
According to the Wall Street Journal, Bank of America,
JPMorgan, and Wells Fargo have 33% of all U.S. deposits. That's
up from 21% in mid-2007, the fastest shift of such a large chunk
of deposits in U.S. history.
And according to Inside Mortgage Finance, these three banks made
57% of all home mortgages in the first quarter. That's up +28%
from 2008.
SNL Financial reports that Citigroup and the other three
financial giants had $7.7 trillion in loans and assets as of
March 31. That's up +56% since the end of 2007. Their combined
assets are nearly twice as big as the assets of the next 46
biggest banks.
These numbers suggest the biggest U.S. banks will ALWAYS be "too
big to fail." The risk to the system is too great for the
government to let any of these companies go belly-up. It's bad
for our country. But it's great for investors: It creates a
floor of value.
Plus, right now, Big Finance stocks are trading at attractive
valuations. All four of the names I mentioned are trading below
10 times next year's earnings. As I showed you in my chart from
"The New Rules of Investing" last week, stocks below 10 times
earnings make a great buying opportunity. Also, with the
exception of Wells Fargo (at 1.3 times book), all these banks
trade below book value. Your risk is pretty limited when you buy
this cheap.
Looking at the upside, over the next 18 months, low interest
rates will create huge profits for these giants. That means it's
just a matter of time before these banks reinstate dividends.
Longer term, these banks will get a piece of every large public
stock offering and M&A transaction for the next 20 years.
At these levels, I suggest adding a big bank to your portfolio
today.
-- Frank Curzio
Editor
Penny Stock Specialist
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