Bret's Big Bank Buys

08/04/2015 8:00 am EST

Focus: STOCKS

Bret Jensen

Editor, Biotech Gems

The environment for major banks is rapidly improving.  Given the sector sells at a significant discount, I have moved this group to heavily overweight within my own portfolio, explains Bret Jensen in Investors Alley.

I have myriad reasons to do so. First, interest rates should continue to rise gradually over the next six to twelve months.

This will help boost net interest margin growth, one of the biggest profit drivers at banks.

Meanwhile, default rates are at historical lows. This will be a continuing tailwind to earnings growth.

Housing is also recovering and this will provide an important earnings driver to major banks.

In addition, legal costs are finally falling. This could be the start of normalcy, which would be a welcome tailwind for the bottom line at major banks in the quarters and years to come.

Also, operational costs are falling. Banks are doing a wonderful job using technology to push operational costs downward.

Finally, now that bank balance sheets have been bolstered and earnings growth has returned, I expect the Federal Reserve to be more lenient in the years ahead allowing banks to return a larger share of their profits to shareholders via dividends and buybacks.

My favorite major bank continues to be JPMorgan (JPM). The shares yield 2.7% with a payout ratio on this year’s likely earnings of about 30%.

I see that payout ratio creeping into the 40% to 50% range as the bank continues to remove the regulators’ yoke and leave the financial crisis aftermath behind. The stock is a solid bargain at approximately 12 times forward earnings.

I consider JPMorgan and Wells Fargo (WFC) to be the best managed large banks out there.

Wells Fargo is a good pick up for investors looking to get more exposure to improving housing and domestic credit growth.

Wells has a limited investment banking presence compared to JP Morgan so is a more a pure play on improving economic metrics. It pays a similar 2.7% dividend yield and fetches 13 times next year’s earnings.

Going out on the risk/reward scale, Bank of America (BAC) is worth a look here. The most troubled of the major bank, BAC just put out its best quarter in years and is seeing legal costs drop dramatically.

It is also seeing a surge in mobile banking allowing the bank to slowly cut branch and employee costs. 

It should have the best earnings growth of major banks through 2016, sells for less than book value, and goes for under 12 times next year’s earnings projections.

It has been a tough half-decade for the major banks; however, brighter skies seem on the horizon.

They offer solid values and will benefit greatly from improving economic conditions, higher interest rates, and a stronger housing market.

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