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Time to Buy the Financials?

11/12/2007 12:00 am EST

Focus: STOCKS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, editor of Investment Quality Trends, says financial stocks are suffering the same kind of negative sentiment other groups have in the past—before rallying.

[We] published the first Lucky 13 portfolio in the January 2000 issue. Of the original 13, four were utility stocks—30% of the total portfolio, [when] the tech and dot-com craze favored capital gains over dividends, relegating high-yielding stocks like utilities to the back bench.

Like the pharmaceuticals of the early 1990s, the utilities at that time were unreasonably depressed and represented good long-term value, which suggested that they be given a prominent place in a value-oriented portfolio.

Today we find a similar environment with the bank and other financial stocks. The reasons for the current undervaluation in the financials are different than those for the utilities in 2000 for sure, but then again, the reasons for undervaluation are always different.

In 2003 Mc Donald’s (NYSE: MCD) was out of favor, trading at $15 with a puny 21- cent dividend and receiving comments like “a dinosaur.” Today that stock trades at $55 and the dividend is $1.50.

Like the examples above, the financials clearly have a mess on their hands. Not surprisingly, more than 30% of the undervalued category consists of financial stocks. It is understandable that subscribers are concerned about positions they have owned for two, three or even four years with little or even negative price appreciation.

Except for the increased dividend payouts over that time, it is difficult to remain steadfast while waiting for the value that exists historically to be realized. This is why dividends and a rising dividend trend are critical to our approach and philosophy.

Fear in the stock market isn’t a new phenomenon; the Wall of Worry is a constant Wall Street companion. Where the present situation diverges from the normal level of worry is that this market is uncertain and nothing is worse on the Street than uncertainty.

While it is clear that some investors have become unhinged, the crisis in the credit markets is real and is probably not over. Look at the recent $8.4-billion write-down by Merrill Lynch (NYSE: MER)—ouch! Of course Merrill is not alone; recent earnings disasters at banks like Citigroup (NYSE: C), Washington Mutual (NYSE: WM), and Bank of America (NYSE: BAC) have put an exclamation point on the fact that the bank’s exposure to falling home prices and risky loans is problematic. With shares priced as if dividend reductions or eliminations are eminent, it begs the question: is this crisis different from past crises?

The honest answer is that no one knows. The two questions that Trendphiles must answer are: do you think the dividends for bank stocks will be drastically reduced or eliminated; or, will the companies go bankrupt? If you answer yes to either of those questions you shouldn’t be holding those stocks. As with the examples of deep undervaluation mentioned previously, we think that this, too, shall pass.

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