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Meat-and-Potatoes Banking Buys

11/21/2014 8:00 am EST


John Dobosz

Editor, Forbes Premium Income Report and Forbes Dividend Investor

With an improving US economy and the strong likelihood that interest rates will creep higher over the next year, it’s a good environment for banks, especially smaller ones that focus on the meat-and-potatoes businesses of deposit-taking and lending., suggests John Dobosz, editor of Forbes Dividend Investor.

Escalating long-term rates and steady short-term rates is the sweet spot for banks, particularly the regional banks with understandable business models focused on borrowing short and lending long.

The spread between these two is profit, and judging by the market’s reaction to the Fed’s announcement to end its bond buying program, it’s a good time to get into banks.

With regional banks looking attractive, we recommending buying a Massachusetts bank sporting hefty discounts to historical valuations and a stable dividend good for a yield of nearly 3.7%.

Brookline Bancorp (BRKL) has 47 branches in the greater Boston area, the North Shore of Massachusetts, and in Rhode Island. It maintains lending and deposit relationships with small and medium-sized businesses, and with individuals.

Valuation relative to history makes a compelling case for Brookline. Over the past five years, the stock has traded for an average price-sales ratio of 3.31, nearly 35% higher than its current multiple of 3.31 times revenue. 

Looking at cash flow, the bargain is even better: BRKL’s current price-to-operating cash flow ratio of 7.9 is 48% below its five-year average of 11.7 times cash flow.

Another timely buy among regional banks is Akron, Ohio-based FirstMerit Corp. (FMER). With roots dating back to 1855, FirstMerit has assets of $25 billion and 381 banking branches in Ohio, Michigan, Wisconsin, Illinois, and Pennsylvania.

FirstMerit has a 25-year dividend history, although it did slice the quarterly payout from $0.29 to $0.16 back in 2009 in the wake of the financial crisis. The current payout is easily covered by earnings with a payout ratio of 46% of expected 2014 EPS.

On valuation, FirstMerit is full of value. It trades for 9 times enterprise value to EBITDA, a 14% discount to its five-year average. It trades at a 12% discount to its average price-to-book value ratio since 2009.

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