Capital One Earns Place as 2012 Bank Stock Pick

NEW YORK (TheStreet) -- Capital One (COF) is getting it done for investors, with two major acquisitions set to raise the company's earnings bar.

Nearly six months ago, I called Capital One the top bank stock pick for 2012, and the shares indeed returned 29% year-to-date through Friday's close at $54.52. That beats the year-to-date returns of three out of the "big four" U.S. banks, with the notable exception of Bank of America (BAC), with a total return of 39%, through Friday's close at $7.74.

Capital One CEO Richard D. Fairbank

Of course, Bank of America's year-to-date performance owes a great deal to the stock's 58% decline during 2011, when Capital One's shares had a flat return, and BAC's shares have pulled back 22%, from their 2012 closing high of $9.93 on March 26.

Bank of America's shares were trading at such a low multiple to tangible book value at the end of the year, that a recovery for the shares seemed quite likely. Then again, giving some further perspective to the numbers, Bank of America's 52-week total return through Friday was a negative 37%, while Capital One's 52-week return was 2%.

Capital One's slide during the second half of 2011 owed quite a bit to the uncertainty surrounding the Federal Reserve's prolonged approval process for the company's acquisition of ING Direct (USA).

That's just the type of uncertainty a confident long-term investor can take advantage of.

Dividend Growth Reveals the Path to Profits >>

The ING Direct acquisition was completed in February, with Capital One booking a first-quarter bargain purchase gain of $594 million, and providing the liquidity needed for the company's next major acquisition.

Capital One in March completed a $1.25 billion common stock offering, which will be used to complete its purchase of HSBC's (HBC) roughly $30 billion U.S. credit card portfolio, for a premium of $2.6 billion. Regulatory approval has been received from the Office of the Comptroller of the Currency for the HSBC deal, which should be completed during the second quarter.

Following what is bound to be another messy quarter with one-time items related to the acquisitions, investors will be looking for Capital One to build on its renewed credit card focus, with improving operating earnings. As we pointed out in our December piece, Capital One's return on average assets ranged between 1.74% and 3.05% during the five year period prior to 2008, when the credit crisis nearly wiped-out the company's earnings in 2008. During those five years, Capital One's shares tended to trade in a range of 14 to 27 times trailing earnings.

At Friday's close, Capital One was trading for just above tangible book value -- according to Thomson Reuters Bank Insight -- and for just eight times the consensus 2013 Earnings estimate of $6.86, among analysts polled by Thomson Reuters. The consensus 2012 EPS is $6.39.

There are plenty of other large banks trading at low multiples to forward earnings and book value:

Based on Friday's closing price of $7.74, Bank of America's shares trade for 0.65 times book value, and for just seven times the consensus 2013 EPS estimate of $1.05. The consensus 2012 EPS estimate is 61 cents. Many analysts have said that the company will be unable to get back to its pre-crisis earnings performance, because of its reduced earnings power in the wake of asset sales, a greatly reduced mortgage presents and regulatory changes -- including the Durbin Amendment's cap on debit card interchange fees.

But those are very low price multiples, making Bank of America a name to consider, for committed long-term investors who are confident in the U.S economic recovery. Over time, as the company eventually settles its legacy mortgage mess from its disastrous purchase of Countrywide and enjoys the benefits of its Merrill Lynch purchase, long-term investors may be rewarded.

Shares of Citigroup (C) closed at $31.60 Friday, returning 20% year-to-date, following a 44% decline during 2011. The shares trade for 0.6 times tangible book value, and for just seven times the consensus 2013 EPS estimate of $4.71. The consensus 2012 EPS estimate is $4.19.

Out of 29 analysts covering Citigroup surveyed by Thomson Reuters, 20 rate the shares a buy, while six have neutral ratings and three rate the shares "Underperform," or recommend selling the shares. Wells Fargo analyst Matthew Burnell is among the believers, with an "Outperform" rating on Citi's shares with a valuation range of $38 to $41, saying on April 25 that his target range represented 0.7 times his 2012 year-end tangible book value estimate of $55.00.

Industry darling JPMorgan Chase (JPM) closed at $41.75 Friday, returning 27% year-to-date, following a 20% decline last year. The shares trade for 1.3 time tangible book value and for eight times the consensus 2013 EPS estimate of $5.60. The consensus 2012 EPS estimate is $4.97.

Considering JPMorgan's stable operating performance over the past year, the stock's valuation seems quite low, and most analysts agree, with 28 out of 34 surveyed by Thomson Reuters rating the shares a buy, while five analysts have neutral ratings, and one lonely analyst rates the shares "Underperform." The mean price target is $52.83.

But Capital One still looks like a winner, since its returns on assets and equity are likely to beat the bigger banks over the long haul. Credit cards are simply more profitable than most other loan types, because of the high interest rates that consumers are willing to pay. And while the bigger banks also enjoy investment banking and trading revenue streams, these can be quite volatile.

Capital One's first-quarter net interest margin -- the difference between a bank's average yield on loans and deposits and its average cost for deposits and wholesale borrowings -- was 6.20% during the first quarter, declining by over 1% from the fourth quarter, "as a result of the on-boarding of ING Direct's lower yielding assets and temporarily high cash balances," according to the company.

Following the second quarter, when those cash balances will be put to work, supporting the HSBC card portfolio purchase, Capital One should see quite a boost in the margin.

For the first quarter, Bank of America's net interest margin was just 2.45%, according to Thomson Reuters Bank Insight, while Citigroup's net interest margin was 2.85%, and JPMorgan Chase's NIM was 2.56%.

Interested in more on Capital One? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.