NEW YORK (TheStreet) -- The big discount for big bank stocks could be coming to an end.
Stocks of the largest U.S. banks have for years been trading at significantly discounted valuations to book value and forward earnings estimates when compare to regional banks, which is understandable because of the big banks' greater regulatory scrutiny, higher capital requirements and litigation risk.
With the KBW Bank Index sliding 5% so far this year, following stellar gains of 35% in 2013 and 30% in 2012, many sell-side analysts have been upgrading bank stocks, including Fifth Third Bancorp (FITB), and other regional banks, while also highlighting other undervalued regional names, including FirstMerit FMER of Akron, Ohio.
KBW analyst Fred Cannon on Sunday, following last week's market panic, wrote in a client note that "emerging markets sell-offs tend to be buying opportunities for financial stock investors, although getting the timing right is difficult. We believe that the current position of U.S. global financial firms-extremely strong capital positions and overall improving credit-should allow history to repeat itself during the current emerging market sell-off."The numbers showing slowing manufacturing growth in the United States and China caused a sharp drop in the broad market and in bank stocks on Monday, setting the stage for what could be a volatile reaction to the Department of Labor's January unemployment report on Friday. Getting back to long-term considerations, Evercore Partners analyst Andrew Marquardt in a note to clients on Thursday wrote, "Large-cap banks are currently trading near peak [price-to-earnings] P/E discount to regional banks with shares at 11.8x [2014 earnings estimates] or a 23% discount which compares to historical closer to 13% (discount peaked in 2011 at over 30%). Importantly, large-cap banks are trading at a ~20% discount to the S&P (modestly less than historical) while regionals are trading at a 3% premium (vs hist 16% discount)." So the big banks are still trading on a historically cheap basis, while the regionals as a group are a bit expensive, since bank stocks typically trade at a lower P/E as a group than the S&P 500. Citigroup (C - Get Report) and JPMorgan Chase (JPM - Get Report) are among the cheapest U.S. bank stocks on a forward price-to-earnings basis. Citi's shares closed at $47.06 Wednesday and traded for 9.4 times the consensus 2014 earnings consensus of $5.01 a share, among analysts polled by Thomson Reuters. Going out another year, the shares trade for 8.2 times the consensus 2015 EPS estimate of $5.76. According to Evercore's data, Citigroup's average current-year price-to-earnings ratio over the past 10 years has been 10.9, while its average P/E ratio over the past 20 years has been 11.5. JPMorgan on Wednesday closed at $55.21 and traded for 9.2 times the consensus 2014 EPS estimate of $5.98 and 8.7 times the consensus 2015 EPS estimate of $6.35. Evercore's data shows JPM's average P/E over the past 10 years at 11.1, with a 20-year average of 11.5. The average P/E figures cited by Evercore exclude 2009, when JPMorgan reported relatively weak earnings and Citigroup posted a huge loss. But those long-term P/E averages imply that there could be quite a bit of upside left to Citigroup and JPMorgan, as Citi continues to right-size its balance sheet and significantly increase its deployment of excess capital, and when JPMorgan rebuilds investors' trust, as it wades through additional regulatory investigations and litigation. The Federal Reserve early in March will complete its annual stress tests for major U.S. financial firms, which will soon be followed by the regulator's review of capital deployment plans. Marquardt expects Citigroup to receive Fed approval to double its quarterly dividend to two cents a share, and also to be approved for $4.265 billion in common-stock buybacks from the second quarter of 2014 through the first quarter of 2015. That would be a major increase from the $1.2 billion in buybacks the Fed approved for Citi in March 2013. For JPMOrgan, Marquardt expects a quarterly dividend increase of a penny to 39 cents, with $3.711 billion in buybacks from the second quarter of 2014 through the first quarter of 2015. That level of buybacks would be a significant decline from the $6 billion approved by the Federal reserve last March. Marquardt on Thursday reiterated his "positive" view on bank stocks, with a preference for large-cap names over regionals, "given valuation disparity which appears to be turning." His "top picks," in addition to Citigroup and JPMorgan, include Bank of America (BAC), BB&T (BBT) of Winston-Salem, N.C., SunTrust (STI) of Atlanta, Regions Financial (RF) of Birmingham, Ala., and SVB Financial Group (SIVB) of Santa Clara, Calif.
Time to Buy Fifth Third Shares, Says BAC Merrill Two 'Top Picks' Among Mid-cap Bank Stocks Follow @PhilipvanDoorn