Some Bank Stocks Are Still Quite Cheap

The financial industry's recovery has continued in full swing, with the KBW Bank Index rising 10% this year through the end of March, following a 30% return during 2012. All 24 components of the index showed year-to-date gains, with the notable exception of Capital One Financial ( COF) with shares declining 5% through Thursday's close at $54.95.

Capital One's underperformance reflects a disappointing fourth quarter and subdued outlook for 2013, with weak credit card loan demand in the U.S. The company last month agreed to sell its $7 billion portfolio of Best Buy ( BBY) credit cards to Citigroup ( C), in a deal that is expected to be completed in the third quarter.

The weak demand for Capital One's core product is reflected in the market valuation for the shares, which trade for 8.2 times the consensus 2014 earnings estimate of $6.68, among analysts polled by Thomson Reuters. At Thursday's market close, only four other components of the KBW Bank Index traded for 9.5 times forward earnings, or lower:
  • Shares of JPMorgan Chase (JPM) closed at $47.46, trading for 8.2 times the consensus 2014 earnings estimate of $5.81 a share.
  • Citigroup closed at $44.24, trading for 8.5 times the consensus 2014 EPS estimate of $5.23.
  • Shares of Bank of America closed at $12.18, trading for 9.4 times the consensus 2014 EPS estimate of $1.30.
  • Wells Fargo (WFC) closed at $36.99, trading for 9.5 times the consensus 2014 EPS estimate of $3.89.

So Capital One is lumped in with the "big four" U.S. banks, which have regulatory and political targets on their backs and are still trading at historically cheap valuations, especially JPMorgan Chase and Wells Fargo, which continue to be solidly profitable.

Bank of America continues to clean up its legacy mortgage mess, which of course includes the potential for several more brutal headlines over the next year or two. Citigroup continues its transformation and, with the company making a modest request for Federal Reserve approval to repurchase $1.2 billion worth of common shares through the first quarter of 2014 and with no dividend increase, the company should continue to rapidly build up excess capital.

With its relatively low valuation and credit card business model, Capital One appears to be a good defensive play among bank stocks. Following the completion of the Federal Reserve's annual round of stress tests, the company raised its quarterly dividend to 30 cents a share from five cents, for a dividend yield of 2.18%.

When considering the low valuation of the big four, the market is sending a pretty clear signal that the large regional banks will be the ones to see the most earnings growth as economic activity continues to recover.

Stress Tests, Buybacks and Higher EPS

Aside from the grilling of current and former JPMorgan executives before the Senate Permanent Subcommittee on Investigations over the "London Whale" hedge trading losses in 2012, the big event for big banks in the first quarter was the completion of the Federal Reserve's annual stress tests.

The Federal Reserve has stuck with its preference of only permitting the largest banks to pay dividends of up to roughly 30% of earnings. For deployment of excess capital, the regulator prefers share buybacks, which offer greater flexibility since they can easily be curtailed at any time. This suits the big banks just fine, since large buybacks can reduce share counts sufficiently to bump up EPS estimates.

Please see TheStreet's Capital Deployment Winners and Losers for more on banks' capital return plans in the wake of the stress tests.

Regional Bank Earnings Previews

Here are third-quarter previews for the five largest U.S. regional banks by asset size:

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