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A Case for Bank Stocks

Lately Kovalski has been focusing on banks that seem to be prime candidates for takeovers. Acquirers often pay premium prices to purchase solid banks. During the financial crisis, merger activity slowed. But since then, the volume of activity has increased. Kovalski says that about 50 banks are taken over each quarter.

Many institutions are selling themselves because it has become difficult for small institutions to cover the costs of complying with new regulations. "A small community bank may have to hire an additional person to handle compliance issues, and that can be a difficult burden" says Kovalski.

A favorite holding is Southern National Bancorp of Virginia (SONA - Get Report), which has 19 branches in Virginia and Maryland. The bank has been expanding by acquiring branches of troubled competitors. Kovalski figures that the bank could be an acquisition target. The company is headed by a husband-and-wife team who earlier built up another bank and sold it.

Another way to benefit from a rise in bank shares is by holding Oakmark I (OAKMX), a large blend fund that has 28% of its assets in financial shares. During the past five years, the fund returned 11.% annually, outperforming the S&P 500 by more than 4 percentage points. The fund's top holdings include JPMorgan Chase (JPM) and Wells Fargo (WFC - Get Report).

Portfolio manager Bill Nygren looks for growing companies that sell for discounts of at least 40% to their fair values. Nygren is particularly keen on Bank of America (BAC - Get Report).

"The company has gotten off the critical care list and is now a sustainable business," he said last week in a talk at the Morningstar Investment Conference in Chicago.

Nygren said that Bank of America has a solid balance sheet, but that the shares sell for only 70% of book value. He said that investors are wary because they fear that the volume of loans cannot increase in the sluggish economy. But Nygren said that the company can produce solid profits, even if the revenue does not increase. "At today's prices, they will have enough capital to buy back 10% of their shares each year," he said.

With the buybacks, the company could reduce the number of its shares outstanding. That would increase earnings per share and help to boost the stock price.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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