It’s Time to Bank on Bank Stocks

04/30/2007 12:00 am EST

Focus:

Richard Band

Editor, Profitable Investing

Richard Band, editor of Richard E. Band’s Profitable Investing, says bank stocks lag the broader market and offer some of the most attractive dividend yields around.

Bank stocks as a group have slowly lost ground versus the blue-chip market indexes (such as the Standard & Poor’s 500) for almost five years now. Investors are understandably losing patience—as they usually do, at precisely the wrong time.

• Banks’ profit margins, compressed by the inverted yield curve, are probably within hailing distance of their cyclical low.Once deposit rates begin to fall, most likely in the latter months of 2007, interest margins—a crucial component in bank profits—will take off.

• Loan losses are likely to be muted in 2007 and beyond. Commercial real estate is still tooling along, business lending is solid, even credit cards are making good money.

•Bank stocks today feature some of the most alluring dividend yields of any market sector. Today, the banks yield 34% more than the REITs and 41% more than the utilities. Banks operate a far more diversified business than REITs or utilities, with a much better long-term record of earnings growth.

Which banks should you buy now?

Citigroup (NYSE: C). Buy Citi for a juicy 4.1% yield and the prospect of doubling your wealth over the next three or four years. Buy C at $54 or less.  (It closed at just above $53 Friday—Editor.)

Fifth Third Bancorp (NASDAQ: FITB). Sloppy, erratic decision-making by ex-CEO George Schafer took the edge off this superb Midwestern franchise over the past few years. But the operative word is “ex.” In January, the board kicked George upstairs to the honorary post of chairman and installed a high-energy successor in Kevin Kabat, 50.

I continue to believe that FITB will eventually sell out to a bigger organization. (Current takeout value, by my reckoning: $45–$47.) With Kabat in charge, though, I’m confident that we’ll get a better price—because he’ll whip the business into fitter shape before talking to suitors. Current yield: 4.3%, after an eyebrow-raising 11% dividend hike in March. Buy FITB at $41 or less. (It closed just shy of $41 Friday—Editor.)

Wells Fargo (NYSE: WFC). Possibly the best-managed bank in the world, California-based WFC sports a pristine triple-A rating from Moody’s on its certificates of deposit—the only U.S. bank with such a distinction. Wells is also a marketing machine. Small wonder the stock has outperformed the S&P by a sweeping margin over the past 20 years, chalking up a 21% compound annual return versus 12% for the index.

Yet lately, despite brisk earnings growth, WFC shares are trading at their lowest P/E ratio (on estimated year-ahead earnings) since 1997. The stock is also yielding 3.1%, unusually generous for this top-drawer outfit. Yes, Wells has made sub-prime mortgage loans, but carefully and in modest amounts. Buy WFC at $37 or less. (It closed slightly below $36 Friday—Editor.)

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