Reese: Three Banks Worth the Investment

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Five years ago, the banking industry was on its knees. My, how times have changed. Some troubled institutions, such as Wachovia and Washington Mutual, did bite the dust, but others have cleaned up their books.

According to the Federal Deposit Insurance Corp., return on equity (ROE) for banks dropped from about 12% in 2007 to 1.4% in 2008 and a low of -3.68% in 2009, and spent the last several years recovering to 10.44% in 2013. That's not quite where things were in the years before the Great Recession when ROE was generally a bit above 12%, but it is quite a reversal of fortune, nonetheless.

The banks are not out of the woods, though. They have improved their profitability substantially (in part due to declines in loan-loss provisions), but top-line revenues have been largely flat. Yet their fairly solid financial footing makes them good candidates for those who need financial institutions in their portfolios in order to achieve asset diversification.

To choose stocks, I rely on a series of computerized strategies I created based on the writings of some of Wall Street's most savvy investors. Peter Lynch is one of history's most storied mutual fund managers, and his strategy currently favors several regional banks. These are all worth considering as investments.

The strategy's most important variable is the P/E/G ratio, which is price-to-earnings relative to growth. Growth is a valued factor when analyzing how much a stock is worth, and the P/E/G is a way to measure the cost of growth to the investor.

The Lynch strategy limits the P/E/G to no more than 1.0. At that level, the investor is paying $1 for every 1 percentage point of growth. A P/E/G of, say, 0.63, is pricing 1 percentage point of growth at $0.63.

Founded more than 140 years ago, Sandy Spring Bancorp (SASR) is a full-service commercial banking, mortgage banking and trust business. Its market is Maryland and Northern Virginia. Sandy Spring's P/E/G is a strong 0.63. Also in its favor is its equity to assets ratio. The minimum needed to get the highest grade from this strategy is an E/A ratio of 5% and Sandy Spring's is a robust 12%.

Fifth Third Bank (FITB) has 1,320 full-service banking centers in 12 states. With the Lynch strategy, a P/E/G below 0.50 is considered particularly strong, and Fifth Third is in this desirable territory with a P/E/G of 0.28. Its E/A ratio is a solid 11%.

Huntington Bancshares (HBAN) operates The Huntington National Bank, which has 700 branches and a geographic area covering six states. This bank's P/E/G is a desirable 0.59 and its E/A ratio is 10%.

The banking sector is on the mend, and these three banks are particularly strong performers. These are banks you can bank on.

Editor's Note: This article was originally published at 2 p.m. EDT on Real Money on March 21.

At the time of publication, John Reese and his clients were long FITB.

John P. Reese is founder and CEO of Validea.com, an investment research firm, and Validea Capital Management, an asset management firm serving affluent investors and companies. He is also co-author of two investing books, including The Guru Investor: How to Beat the Market Using History's Best Investment Strategies (Wiley). Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback. Click here to send him an email.

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