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One thing's for sure: Investors are fickle about financials.
Conflicting opinions cloud the industry's true state. But on the basis of growth potential and valuation, financial-services stocks are attractive.
A breakdown of analysts' recommendations reveals that
Bank of America
now receive "buy" recommendations from more than 50% of those who publish reports and "sell" ratings from 4%. That's a bullish shift.
, the industry laggard, receives 17% buys and 39% sells, and Wells Fargo gets 40% buys and 24% sells.
The reasoning behind the optimism is consistent: improved trading spreads, gains from the equity and commodities rally that began in early March, higher advisory and underwriting fees, cheaper access to capital markets and signs of economic improvement. Of course, there's a herd mentality in the research community. The majority of so-called experts failed to predict the subprime meltdown.
Consequently, it's important to consider outlier opinions.
Michael Mayo, the ever-contrarian
analyst, is an outspoken bear. In his April 6 research note, "The Seven Deadly Sins of Banking," Mayo warned that the ratio of loan losses to total loans at major institutions could top levels reached during the Great Depression. He projected that loans were modestly marked down to just 98 cents on the dollar.
Since Mayo's infamous note, the market was surprised by first-quarter profits and the
Russell 1000 Financial Services Index's
18% gain. But Mayo has maintained his bearish stance and currently has "underperform," or "sell," ratings on all of the aforementioned stocks.
TheStreet.com Ratings' proprietary model is pessimistic about the financial sector, slapping "holds" and "sells" on brand-name stocks.
The highest marks go to Goldman, which receives a C grade and a financial strength score of 8.9 out of 10. The industry gets an overall rating of 3.2 out of 10, which works out to a C-minus, or "hold."
TheStreet.com Ratings' 100-strong "buy" list includes small-cap lenders, niche capital-markets firms and high-yield real estate investment trusts.
A prevalent criticism of financials is excessive valuation. The Russell 1000 Financial Services Index has surged 76% from its March low. But even at current prices, bargains exist. In fact, value relative to earnings potential is the sector's strongest selling point. The following table shows that.
(About the table: All figures were calculated using prices from the market close on June 19 and First Call consensus estimates. The bullish-scenario price-to-earnings ratio represents the most bullish 2010 earnings estimate from a Wall Street analyst.)
Looking at the Dow's 14,093 peak on Oct. 12, 2007, the per-share market value of Bank of America,
stood at $53, $23 and $18, respectively, or a cumulative price of $94. Today, the combined companies trade at around $13. Bank of America is unlikely to hit $94 soon. But $13 is equivalent to 14% of its previous market value. That's a heady discount.
Since Standard & Poor's downgraded a swath of regional banks last Wednesday, the Russell 1000 Financial Services Index has risen 2.3% and Bank of America has increased 3.2%. That suggests investors have their own ideas about financial shares.