Two events last week created buying opportunities in financial and insurance stocks.
Bank of America
announced Wednesday a zero-trading-commissions promotional campaign that temporarily drove down shares of several online brokers.
Second, three very large pension insurers made presentations in New York on Friday about the Pension Protection Act of 2006.
Life insurers are likely to experience greater deposit growth from new contribution limits and automatic enrollment features provided by the Act; expect Wall Street analysts to get this message as third-quarter earnings roll out.
In response to these events, we give you the TheStreet.com Ratings' five best large-cap buys in the financial services sector.
To make this list, a stock has to score in the top 10th percentile in cash flow, total return to shareholders, capital efficiency, low price volatility and solvency -- the five core factors in our stock ratings model.
The focus here is on developing a bulletproof portfolio based on recent performance history of the company and the stock.
In terms of potential appreciation, all our models point to large-cap growth continuing to outperform. The biggest beneficiaries in the financial services industry will be the companies with the largest growth in assets under management.
There are two ways for a company to accomplish this: add more new deposits or acquire other money managers.
Naturally, the biggest earnings leverage will come from companies that can also improve margins on their portfolios under management as they grow.
Here, then, in order of their overall rating, are the five financial stocks that fit this profile and meet our investment criteria.
Five Fabulous Financials
Source: TheStreet.com Ratings
: Lincoln National is one of three companies that commented on the Pension Protection Act, and its stock is now up 21% year to date, aided by consistent cash returned to shareholders via dividends and share repurchases of more than $700 million.
The company has a history of shedding non-asset-gathering businesses and adding assets such as Delaware Investments, Cigna Life and Jefferson Pilot to its lineup. As of the mid-2006, LNC had $151 billion of assets under management, up 37% in 12 months. About two-thirds of this total comes from retail clients, and one-third from institutions.
Our model likes this stock on most measures, but indicates that capital efficiency is not as high as expected. With projected excess capital of $500 million for 2007, management's strategy to boost returns by returning cash to shareholders appears sustainable. As such, LNC presents a great total return story with potential for substantial appreciation if the company is acquired by a global financial services company. The company is expected to report earnings Oct. 31.
: The combination of
PNC Financial Service Group's
asset-management businesses has amassed a stable of managers with $1 trillion in assets under management.
Still, this global powerhouse is just beginning to establish its new brand name. Few managers can compete with BlackRock's scale and scope of operations. Expect it to consistently show well-above-average growth relative to its U.S.-based peers in the years ahead.
BlackRock is one of the few stocks to which our model gives consistently high marks. The stock is now up 37.8% year to date, and analyst estimates indicate another solid growth year, with expectations climbing on the basis of the merger. The company is expected to report earnings Oct. 30.
: If the game is assets, Schwab is the one to watch; it has over $1.3 trillion of assets under management. With improving margins at the U.S. Trust operation and a broad array of mutual funds, Schwab's net income levels have definitely been on the mend since the return of the founder in mid-2004. This has not gone unnoticed; Schwab shares have risen 20% year to date and closed less than $1 off its 52-week high on Friday.
Our stock model gives Schwab solid marks for top-line net revenue growth and high profitability. It also ranks highly on total return and solvency.
The one area to watch is stock volatility, but we believe concerns about Bank of America's zero-trading-commission plan may be an overreaction. A diverse portfolio of assets under management, Schwab's focus on active high-end accounts and an increasing range of value-added services help differentiate it from other discount brokers.
Monday morning, the San Francisco-based firm said net new assets totaled $21 billion in the third quarter, while total client assets rose 14% to a record $1.332 trillion. The company also reported third-quarter earnings of 21 cents per share, up from 16 cents a year ago and a penny ahead of consensus estimates. At $1.29 billion, net revenue rose 13% but was a bit shy of the consensus forecast of $1.3 billion. In recent trading, Schwab shares were down 33 cents, or 1.9%, to $17.23.
Principal Financial Group
: The model's fourth financial pick is the one that is most likely to directly benefit from the new pension legislation. The new annuity option for defined contribution plans and investment-adviser features will help the firm's new sales efforts.
Principal Financial has $206 billion of assets under management, with about half of this coming from its pension business. The acquisition of
WM Advisors adds another $12 billion of life cycle target-risk funds under management.
WM Advisors is best known for its expertise in asset allocation through its Strategic Asset Management Portfolios, a series of five fund-of-funds creating different investor risk profiles or target-risk funds. These lifestyle funds are frequently used as default investment options in pension plans. As the leading provider of corporate defined contribution plans, Principal Financial is well-positioned for the projected surge in retirement funding.
Our stock model likes this $14.7 billion market-cap, low-volatility stock that has delivered a 15.7% year-to-date return, well above that of the overall market. The model gives Principal Financial high marks for above-average growth and high capital efficiency. The company is expected to report earnings Oct. 31.
PNC Financial Service Group
: Rounding out the top five is a bank that experienced a windfall gain from its participation in the BlackRock merger and reinvested in a strategic regional acquisition. The Pittsburgh-based bank is paying $47.24 a share for the Baltimore-area lender
, which has $17 billion in assets and 240 branches, primarily in Maryland and Washington, D.C. The deal, which will give PNC more than 1,000 branches on the East Coast, is the fourth-largest bank merger this year.
The stock ranks highly on total return, up 15.7% year to date. Our stock model indicates that the historical growth and solvency have been average, two things the pro forma bank combination will address.
The combined entity also will show improved margins due to addition of less costly deposits and lower fixed costs with overhead consolidations. For the near term, this is still primarily an indirect, lower-volatility play on the growth of BlackRock, given that PNC still retains a significant ownership percentage along with Merrill Lynch. PNC is expected to report earnings on Oct. 31.
As we always caution, before proceeding to the names on the list, note that just filtering stocks on a set of financial or technical criteria alone can expose your portfolio to risk. Also remember that past performance is not a guarantee of similar future gains, especially for a nondiversified list of stocks.
Rudy Martin is the director of research for TheStreet.com Ratings. In keeping with TSC's Investment Policy, employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.
In keeping with TSC's Investment Policy, employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.
While Martin cannot provide investment advice or recommendations, he appreciates your feedback;
to send him an email.