Investing in European Banks: Winners and Losers

NEW YORK (TheStreet) -- After a dismal first half of the year with continued litigation for some banks, economic weakness in Europe and geo-political tensions in the Middle East and Russia, the European banks have taken it on the chin and so have their investors. The iShares MSCI Europe Financials (EUFN) , a broad-based European financials ETF, is down almost 3% for the year, but down almost 9% from its high on June 6. The fund's holdings include: HSBC Holdings (HSBC) , Banco Santander (SAN) , Lloyds Banking Group (LYG) , BNP Paribas BNP, UBS  (UBS) , Barclays  (BCS) and many others.

Compare this to the most popular U.S banking index -- the Financial Select Sector SPDR ETF (XLF) , with holdings in Wells Fargo (WFC) , JPMorgan Chase (JPM) , Bank of America (BAC) , Citigroup (C) and others -- is up 7% for the year and is currently trading at its year-to-date high and up almost 14% off the lows from February 2014. The chart below summarizes the year-to-date performance of the two funds:

So with major U.S. banks making 52-week highs earlier in the year and now getting ready to test those highs coming into the third quarter, what about the beaten down European banks? Of 12 largest European banks, only 25% have hit new highs within the last three months compared to 40% of the largest U.S. banks hitting new highs in that same period.

If you are a value investor and seek to maximize your return on beaten down European bank names, here is a list of those banks and how far off their 52-week highs they are:

The table above is sorted by those banks with the highest financial strength rating through mid-year and then by the percentage off their 52-week highs. FSR is an indication of how well the bank is managed on a financial basis (capital, asset quality, profitability, liquidity and stability). The average price target and expected 12 to 18 month return are part of the stock analysis.

The estimate beats over the last three years and 90-day revisions (up or down) provide a good indication of the reliability of those earnings estimates and the likelihood that those price targets or returns will be hit in the future. Average 10-day volume was included to show how liquid the stock is for trading purposes -- the higher the volume the easier it would be to trade (buy/sell) the stock.

Best Plays: Winners

The best global bank investments for the next 12 to 18 months would tend to be those that are reasonably well managed with decent expected returns, strong volume and low downward revisions. It should be noted that although none of the banks have high-percentage estimate beats over the last three years, the more you compromise on the other criteria, the greater the risk.

  • HSBC Holdings is well managed and although only 6% off its 52-week high (set in Sept. 2013), once some of the litigation concerns are settled, this stock is poised to return between 20% and 30%. The bank has decent volume on the NYSE and average revisions downward of 5% indicating fairly reliable earnings estimates.

The other names in the group that are well managed have some deficiencies that make them a bit riskier. Credit Suisse has below-average trading volume and higher downward revisions than the group but the highest projected returns of 40% to 80%. Barclays has above-average trading volume, high expected returns and is well off its 52-week high, but 3 times the average in downward revisions with 0% estimate beats in the last three years making for unreliable earnings estimates going forward. UBS AG has fairly reliable earnings estimates, strong volume and well off its 52-week high, but only modest returns of 0% to 20%, which is below the group average.

It should be noted that none of the well managed banks are within the eurozone.

Worst Plays: Losers

Royal Bank of Scotland has a poor financial strength rating primarily because it is not profitable and very low trading volume compared to the group. The stock is only 5% off its 52-week high set in March 2014, which is the worst in the group. Although the bank has the highest percentage in upward revisions and decent forecast returns of 20% to 30%, it has no recent earnings estimate beats. Deutsche Bank also has a poor financial strength rating, but the ultimate value play of the group, since the bank is the highest percentage off its 52-week high (36%) set on January 2014. However, it is also very risky with the worst downward revision percentage in the group at 26%.

Other Notables

The others in the group worth noting are Banco Santander, which appears to be fully valued, and Lloyds Banking Group, which may be the sleeper of the group, if you can stomach a low share price at $5.13. The bank trades at the group average in volume and had decent upward revisions with expected stock returns in excess of 50%.

It's worth noting that all of these banks lsited have significant economic and geo-political risks in the area compared to the U.S. and Canadian banks I covered in my last two previous articles: U.S. Bank Tops the 5 Best-Managed Financial Institutions to Trade and Want to Invest in the Global Banking Sector? Think Canada.

Also, see prior article in the Trading Bank Earning series on global banks for further historical analysis of the group.

At the time of publication, the author held positions in C, BAC, WFC, and SAN.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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