NEW YORK (TheStreet) -- How can you get the most out of "nontraditional" banks stocks?
In this third installment of my Trading Bank Earnings series we look at the nine largest publicly traded financial service firms including such familiar names as Charles Schwab (SCHW - Get Report), Morgan Stanley (MS - Get Report) and Goldman Sachs (GS - Get Report).
Unlike the money center and regional banks that focus primarily on traditional retail banking services (deposits and lending money), these and the other six firms, although chartered as banks, have primary lines of business that include credit card companies, investment brokers and asset management firms.
Of course, retail banks, analyzed in the previous articles in this series (Trading Bank Earnings Part 1 and Trading Earnings, Part 2), do have crossover business into other lines, too, but they do not make up a majority of their business.
The financial service companies, as a group, performed well, with six of the nine largest companies beating analysts' estimates. So how can you profit going forward?
Among the groups I follow, the financial service companies had a 67% rate of meeting or beating analysts' estimates and stock price appreciation of 1.6% over three weeks (ending May 2), and well ahead of all other groups including the four money center banks, at 0.4%, the nine regional banks, at 0.5% and the eight global banks, at 0.9%.
Of the sub-groups within the financial service banks, investment brokers performed the best with a 100% beat rate and 2.8% stock price appreciate in three weeks with credit card companies a close second. The table below indicates key metrics and highlights which banks met or beat earnings and those that missed and by how much.
The financial service type banks that beat first-quarter 2014 expectations were: Capital One Financial (COF - Get Report), which beat by a group leading 16%; Goldman Sachs, beat by 15.5%; Morgan Stanley, by 13.3%; Charles Schwab, beat by 9.1%; Discover Financial Services (DFS - Get Report), by 4.8%; and American Express (AXP - Get Report), by 2.3%.
Three banks in the group missed estimates: State Street Corp. (STT - Get Report), missed by 1%; Northern Trust Corp. (NTRS - Get Report), by 3.8%; and the biggest miss, newly publicly traded Ally Financial (ALLY - Get Report) by 21.4%. This makes the eighth miss in a row for Northern Trust and the five of 12 of the last quarters for State Street. Ally Financial just became public on Jan. 28.
Based on stock price appreciation and earnings performance, the winners of this group were Morgan Stanley, Charles Schwab and Capital One Financial, which all handily beat the first quarter 2014 estimates and had significant stock price performance over the last 22 days, just prior and after earnings ended May 2. The most consistent of the group were American Express, which has now beat in all of the last 12 quarters with stock price increase of 2.3% and Goldman Sachs which beat in 10 of 12 of quarters and had a stock price appreciation of 1.9%.
Goldman Sachs', Morgan Stanley's and Charles Schwab's excellent results were bolstered by healthy quarter over quarter revenues increases of 5.7%, 7.3% and 7.1%, respectively. Northern Trust was the only stock in the group not to have a positive stock price performance during the three weeks just before and after earnings season (as of May 2).
I've written about Goldman Sachs, Capital One and Morgan Stanley and all outperformed by exceeding estimates and performance.
If you missed the short-term appreciation on this financial service banking group, how can you profit if you are a long-term investor with a buy-and-hold strategy? The table below shows the revised fiscal year earnings estimates for 2014 and 2015 along with price targets and potential returns.
Over the next year, the best plays based on current valuations and stock price appreciation for FY2014 would be Goldman Sachs, Capital One and Discover Financial, all with expected stock returns greater than 39% based on a historical industry price-to-earnings ratio of 15.
Current stock prices would give these stocks some of the lowest forward looking P/E ratios, at between 10 to 11 times. The most reliable of these stocks appears to be Goldman Sachs since they have beaten estimates 83% of the time since 2011.
The most reliable group for a longer-term investment (2015) would be Charles Schwab and Morgan Stanley as both of these bank stocks had the best stock price return potential for 2015 of 21.6% and 18.5%. However, a note of caution that although both of these stocks beat the 75% over the last 12 quarters, the variance between best upside surprise beats and worst misses is the widest in the group. In addition, Charles Schwab is very expensive at almost 3.5 times book value while Morgan Stanley is less than one times book.
As a result, the safest long-term play for 2015 might again be Goldman Sachs with only 1 times book value and a forecasted FY2015 stock price appreciation of 7.1%. American Express would be another long term play but for a 4.6 times book value, making it an expensive stock.
As a group, the financial service style banks outperformed the money center banks and the "super regional" banks in short-term stock appreciation since the first quarter 2014 earnings season were announced with the non-traditional banks showing a 3% aggregate return versus a decline of 0.3% for the money center banks and 1% appreciation for the regional banks, as of May 12.
This group also outperformed the big banks and regionals in average return earnings estimate beat with an average beat of 8.1% for the financial service banks versus an average beat of 3.1% for the regional banks and a miss of 2% for the money center banks. The group also provides a modest average dividend return of 1.6%, which is better than the money center banks but less the than regional bank group.
The money center banking group still has the advantage over the other groups and are expected to outperform the "super regionals" and financial service banks (listed here) in long term expected returns based on fiscal year earning estimates for 2014 and 2015. The big bank group average stock price return for FY 2014 is expected to be 38% while the non-traditional banks are only forecasted to appreciate a modest 18.7%.
The gap closes somewhat in FY 2015 with the mega banks forecasted to return 13.7% and the non-traditional banks up 10.7% based on an historical price to earnings ratio of 15 times. However, both returns for 2014 and 2015 for the financial service banks are better than the "super regional" groups. Of course, these forecasts are predicated on the banks being able to meet earning estimates going forward and some of the banks in both lists are vulnerable to downward revisions after having missed the current quarter estimates.
At the time of publication the author had no position in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.