Goldman's 7 Best Financial Stocks for 2011

BOSTON (TheStreet) -- Financial stocks, among the laggards of 2010, may rebound in 2011 as value comes into vogue. Goldman Sachs favors the following seven financial stocks, which made its 2011 Conviction Buy List. All are still rated "buy" and expected to rise as much as 20% in the next year. Below, they are ordered by upside, from least to most.

7. Principal Financial ( PFG) is an insurance and investment management company.

Principal is due to release fourth-quarter results today. It has an average earnings surprise average of 4.8% and moves 4%, both up and down, in reaction to earnings announcements. Principal's stock has soared 50% in the past 12 months, easily outpacing indices, and 13% in the past three months. Consequently, it has passed many of analysts' price targets. Goldman is still bullish, but predicts just 7% of remaining upside in the next 12 months.

Principal receives "buy" ratings from just 26% of researchers evaluating its stock. But, it is still notably undervalued relative to its peer group. The stock trades at a forward earnings multiple of less than 12, a book value multiple of 1.2 and a cash flow multiple of 4.5, 21%, 70% and 71% industry discounts. The stock pays an annual dividend, which fluctuates depending upon operating results. This year's 55 cent annual payout translated to a 2% yield on payment.

6. NASDAQ OMX Group ( NDAQ) provides trading, exchange technology and securities listing to companies worldwide. It operates the NASDAQ stock market, home for technology shares.

The company has seen a tremendous rebound in profitability since the market rally began in 2009. NASDAQ's fourth-quarter adjusted earnings advanced 20% to 55 cents, exceeding analysts' consensus target by 8.5%. Its top-line figure, down 3.9%, outperformed consensus by 5.1%. NASDAQ OMX's operating margin widened from 20% to 22% in the latest quarter as expense growth dropped.

Despite the solid earnings beats, NASDAQ receives lackluster reviews, with 10 "buy" calls and 12 "hold" recommendations. In addition to Goldman, Barclays is optimistic about NASDAQ, ranking its stock "overweight" and predicting another 20% of upside to $32. The stock sells for a forward earnings multiple of 9.7, an attractive 16% discount to the specialized finance industry average. Its PEG ratio, a measure of value relative to growth, of 0.5 reflects a 50% discount to estimated fair value. Recent acquisitions, including Nord Pool and Zoom Vision, are bolstering the company's global platform. Its share-repurchase program lessened the float 6.2% year-over-year.

Goldman removed NASDAQ from its Conviction Buy List on Jan. 12, but maintained its "buy" rating and target. Many near-term catalysts were realized. NASDAQ's stock has jumped 21% in three months. Goldman still likes the company's longer-term prospects.

5. Citigroup ( C) is a diversified financial-services company, with retail-, commercial- and investment-banking units. The company was on the brink of bankruptcy two years ago, weighed down by subprime mortgage investments gone bad. Citigroup's stock traded for less than $1 in early 2009.

Citigroup swung to an adjusted fourth-quarter profit of four cents from a year-earlier loss, but missed analysts' consensus target by 48%, sending shares down more than 6% in reaction. Citigroup's sales figure missed consensus by 6.4%. Still, its stock, among the heaviest-traded in the market, receives positive reviews from researchers, with 16, or 53%, "buy" recommendations, nine "hold" ratings and three "sell" rankings. It is up 52% in 12 months.

Goldman's $5.50 target suggests a one-year potential rise of 13%. Dick Bove, at Rochdale Securities, remains the stock's greatest advocate, forecasting an advance of 42% to $6.96. Citi's stock is still cheap relative to financial-services peers, costing 8.7-times forward earnings, 0.9-times book value and 1.3-times sales. Those figures reflect discounts of 25%, 10% and 31% discounts to industry averages. Citigroup has reformed its risk profile markedly since the recession. Its Tier I common ratio widened to nearly 12% in the latest quarter and leverage fell to 12:1.

Goldman, dismayed by lower capital-markets revenue during the quarter, is encouraged by Citi's asset sales, strengthening balance sheet and emerging markets exposure. Citi Holdings is shedding assets faster than anticipated, which is bolstering liquidity. Investment-banking revenue increased 25% during the quarter.

4. Blackstone ( BX) is an alternative-investment company, structured as a publicly traded partnership, which invests roughly $104 billion of fee-generating assets in private equity, real estate and hedge funds. The firm also has an advisory unit, offering merger and acquisition, restructuring and reorganization assistance. It's currently overseen by billionaire investor Stephen Schwarzman.

Goldman expects several of Blackstone's funds to surpass so-called high-water marks and to resume charging performance fees in 2011. Furthermore, It thinks funds could attract another $7 billion. Blackstone reported quarterly results Feb. 3.

Blackstone posted fourth-quarter economic net income, profit excluding taxes and certain charges, of 46 cents a share, beating Goldman's estimate of 30 cents. On a GAAP basis, the company's loss decreased 92% to $11 million, or three cents a share, from $143 million, or 46 cents, a year earlier. Its 32 cent distribution beat Goldman's forecast of 24 cents. Goldman boosted its price target to $20 in reaction to the report. It now expects 86 cents of 2011 distributions, equivalent to a yield of more than 5%. Goldman says Blackstone is "in the sweet spot for both growth and income (from rising distributions amid portfolio realizations) and we still see room for further multiple expansion."

3. Digital Realty Trust ( DLR) is a real estate investment trust specializing in data centers.

Goldman is bullish on the data storage REITs due to "compelling data and cloud-driven IT demand trends coupled with lagging near-term supply growth." Digital Realty's scheduled to report fourth-quarter results Feb. 18. Its stock has climbed nearly 7% since Goldman added it to the Conviction Buy List, but still has 17% of upside potential. It is cheap relative to other REITs based on funds from operations. Its cash flow multiple of 15 reflects a 20% peer discount.

Since 2008, Digital Realty has grown sales, net income and earnings per share 29%, 30% and 61% a year, on average. Its stock delivered annualized gains of 14% over that span. Currently, 13, or 65%, of researchers advise purchasing the REIT, four say to hold and one recommends selling. The stock yields 3.9% and the distribution has grown 37% in the past 12 months. The payout has grown 20% and 15% annually, on average, over a three- and five-year span, respectively.

2. T. Rowe Price ( TROW) is an investment-management company, poised to benefit from a rising equity market. The company sold its first mutual fund in 1950. It is a pioneer in the market.

Flow data indicates that institutions and retail investors are embracing equities in 2011, a trend Goldman expects to continue. Consequently, asset managers will "generate significant cash to buy back stock and pay dividends." Growth in passive strategies, including ETFs, and international exposure are long-term cyclical drivers for the group. T. Rowe, with 73% of assets under management in equities, is Goldman's top pick in the industry for 2011.

T. Rowe's high-proportion of top-ranked funds positions it as a favorite of institutions and individuals. According to Goldman, T. Rowe has "one of the highest and most consistent organic growth rates in the asset management space, averaging 8% annually since 2002." It has a significant presence in the flow-stable retirement channel, giving it momentum for the first quarter, usually the firm's best for attracting retirement assets. T. Rowe's stock commands a premium, which Goldman says is "worth it." It sells for a forward P/E of 17 and a cash flow multiple of 32, notably more than the average asset management peer. It has returned 8.5% a year, on average, since 2008.

1. JPMorgan Chase ( JPM), like Citigroup, is a diversified financial-services company, albeit one with a better track record and reputation.

JPMorgan's fourth-quarter adjusted earnings rose 84% to $1.12, beating analysts' consensus forecast by 12%. Its top-line tally, up 13%, exceeded expectations by 7.8%. The bank is lending more. Loans grew 1%, up in five of six business units. Trading revenue was down 8%. The bank's net interest margin, at just below 2.9%, missed Wall Street's target of 3%. Still, the quarter was considered an overwhelming positive, with JPMorgan topping the investment-bank league tables for global fees, even though its operating profit dropped 24%.

JPMorgan's retail and card-services businesses swung to profits from year-earlier losses. Amid a strengthening recovery, diversified financial stocks have fallen out of favor, but JPMorgan is expected to more than double its dividend in 2011. Based on aggregate ratings, JPMorgan is analysts' favorite Dow component. It receives 28 "buy" recommendations and five "hold" calls. No researchers rank JPMorgan "sell." Although Goldman rates the stock "buy", its $54 target is below the median, at $54.29. Barclays forecasts that the stock will rise 32% to $60 in 12 months.

-- Written by Jake Lynch in Boston.

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