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Warren Buffett's Bank Stock Picks Show Value

Since the 2008 Wall Street crash pummeled most bank stocks and a March 2009 stock bottom led to a tripling of the shares of megabanks like Citigroup and Bank of America, and a doubling of JPMorgan and Goldman Sachs within a span of just over a month, many financial sector investors and analysts forecast that those gains could be replicated.

Instead, the nation's largest investment banks have underperformed, even as their shares gyrated upwards on misplaced optimism of a durable trading or deal making surge.

From March 2009 to May 2009, the largest investment banks were among the financial sector's top performers -- since then, Morgan Stanley, Bank of America, Goldman Sachs and Citigroup shares have all lost over 15% -- and are among 10 S&P 500 bank stocks out of 85 in total that have lost double digits since May 2009, according to Bloomberg data.

While JPMorgan has gained roughly 20% since then, the Bloomberg data shows that Buffett financial sector picks like Wells Fargo, US Bancorp and M&T have dramatically outperformed those returns.

The data should tell investors that in spite of the press given to capital markets players with volatile earnings, they may be better off following Buffett into less glamorous banks stocks that are exposed to consumer and mortgage lending growth.

Earnings confirm the strategy. In fact, it was strengthening lending gains, which propelled earnings at Wells Fargo far higher and that was a rare bright spot at money-center giants like JPMorgan.

In second quarter earnings, Wells Fargo beat estimates on a 35% jump in quarterly profits, bolstered by mortgage lending and other housing-related activity. Amid recovering new and existing home sales, JPMorgan reported its mortgage loan origination revenue grew nearly 30% year-over-year and 14% sequentially to $43.9 billion. Other areas such as its investment bank saw a sharp revenue and profit drop.

JPMorgan's home lending-based earnings boost proved to be among the quarter's most notable positives, amid an earnings season market by a sharp drop in investment banking revenue and a $4.4 billion 'London Whale' trading loss. Across Wall Street, traditional investment banking revenues fell sharply - by nearly 50% in the case of Morgan Stanley - as large bank earnings were clouded once more by one-time accounting items. Meanwhile, the prospect of a rate-fixing scandal that start with Barclays (BCS) and spread continues to cloud some large cap banking giants.

"With roughly 80% of the banking industry by assets having reported 2Q12 results, the overarching theme of earnings has been continued impressive mortgage banking revenues, surprising [net interest margin] resilience, and modest loan growth," wrote FBR Capital Markets analyst Paul Miller in a July 23 earnings wrap. "Given a sustained low rate environment, government mortgage programs, and constrained market capacity, we believe that mortgage banking will continue to be a dominant earnings driver through the end of 2012," he added.
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