Discover Tops List of Cheapest Banks With Greatest Returns

NEW YORK ( TheStreet) -- A deep data dive shows there are still bargain bank stocks out there, despite the industry's overall recovery over the past two years.

The KBW Bank Index ( KBW) has returned 25% this year, following a 30% return during 2012.

It's getting harder for investors to identify bank stock bargains, and the continued political and regulatory onslaught against the largest U.S. banks is holding back their valuations. Shares of JPMorgan Chase ( JPM) closed at $51.95 Tuesday and appear very cheaply priced at 8.6 times the consensus 2014 earnings estimate of $6.02 a share among analysts polled by Thomson Reuters. But the company booked a net loss for the third quarter as it set aside litigation reserves and may see another rocky quarter or two over the next year, as it seeks to make multiple settlements with the Department of Justice, regulators and investors.

Many investors will shy away from JPMorgan because of the regulatory uncertainty. They may well be missing out on a bargain long-term play.

For these investors, looking to avoid negative surprises, we have isolated the U.S. banks that have achieved returns on average tangible common equity of over 15% for each of the past five quarters and that trade at the lowest forward price-to-earnings ratios. The data was provided by Thomson Reuters Bank Insight, and was limited to banks for which third-quarter data was available and for which a consensus 2014 EPS estimate was available.

We used returns on average tangible common equity (ROTCE) in order to leave out intangible assets, such as goodwill, and to leave out earning paid out to preferred shareholders.

We have identified 11 actively traded U.S. bank holding companies achieving ROTCE of over 15% over each of the past five quarters. This approach excludes many possible bargains; however, some of the names are attractively priced when considering the strong returns, relatively low risk and prospect for EPS improvement through share buybacks and increased dividends as excess capital is deployed.

Among this group, Discover Financial Services ( DFS) has the lowest forward price-to-earnings ratio. The company's shares closed at $51.92 Tuesday and traded for 10.2 times the consensus 2014 EPS estimate of $5.07.

Not only is Discover the cheapest stock to forward earnings among the group of 11 we identified, the company has been the strongest earnings performer by far, with ROTCE ranging from 14.79% to 19.05% over the past five quarters.

KBW analyst Sanjay Sakhrani in a phone interview on Tuesday said some investors were frustrated at Discover's relatively low valuation and discussed the possibility of the company unlocking value by selling its payment processing network.

Sakhrani rates Discover "outperform," with a $61 price target.

Here are the next five cheapest stocks among 11 actively traded U.S. bank holding companies achieving ROTCE of over 15% over each of the past five quarters, by descending forward P/E ratio:

Shares of Taylor Capital Group ( TAYC) of Rosemont Ill., closed at $23.01 Tuesday, returning 27% this year. The shares trade for 15.1 times the consensus 2014 EPS estimate of $1.52. The company's ROTCE has ranged from 15.49% to 24.13% over the past five quarters. Taylor Capital has a deal in place to be acquired by MB Financial ( MBFI) of Chicago, which is expected to be completed by the end of the year. For each share, Taylor Capital shareholders will receive 0.64318 shares of MBFI common stock and $4.08 in cash. That comes to a slight premium of $23.19 a share, based on MBFI's closing price of $29.71 on Tuesday.

Next is State Street ( STT) of Boston, with shares closing at $70.80 Tuesday, for a year-to-date return of 52%. The shares trade for 13.6 times the consensus 2014 EPS estimate of $5.19. The company's ROTCE has ranged from 15.45% to 21.92% over the past five quarters. Please see TheStreet's earnings coverage for a discussion of the company's third-quarter results.

M&T Bank ( MTB) of Buffalo has seen its stock return 15% this year through Tuesday's close at $111.43. The shares trade for 13.1 times the consensus 2014 EPS estimate of $8.49. The bank is a strong performer, with ROTCE ranging from 18.03% to 22.39% over the past five quarters.

M&T in August 2012 agreed to acquire Hudson City Bancorp of Paramus, N.J, in a deal originally valued at about $3.7 billion in cash and stock. The merger was expected to be completed during the second quarter, but the two companies in April announced that the time needed to gain regulatory approval of the deal would be "extended substantially," because M&T had "learned that the Federal Reserve has identified certain regulatory concerns with M&T's procedures, systems and processes relating to M&T's Bank Secrecy Act and anti-money-laundering compliance program."

The two companies extended the date after which either company could walk away from the deal until January 31, 2014, but also said in April "there can be no assurances that the merger will be completed by that date."

M&T's shares seem to have been held back this year by the delay to the Hudson City deal, but the there's no denying the bank is a solid performer.

U.S. Bancorp has been a very strong, consistent earner over the past 10 full years, as we discussed back in May. USB's shares closed at $37.67 Tuesday, for a year-to-date return of 20%. The shares trade for 11.8 times the consensus 2014 EPS estimate of $3.20. The company's ROTCE has ranged from 22.41% to 25.00% over the past five quarters, putting it in second place to Discover among the banks listed here. Please see TheStreet's earnings coverage for a discussion of the company's third-quarter results.

Wells Fargo ( WFC) since the credit crisis in 2008 has consistently been the strongest performer among the "big four" U.S. banks, which also include JPMorgan, Bank of America ( BAC) and Citigroup ( C). The company's shares closed at $42.63 Tuesday, retuning 27% this year. The stock trades for 10.6 times the consensus EPS estimate of $4.01. Wells Fargo's ROTCE has ranged between 17.48% and 18.77% over the past five quarters. Please see TheStreet's earnings coverage for a detailed discussion of the company's third-quarter results.

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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