In Banks We Trust

12/10/2009 1:00 pm EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, says one trust bank has the right DNA to thrive in the choppy market he sees in the years ahead.

Grateful? You bet I am. During the first two months of this year, it seemed as if the financial world was falling apart. Today, your stocks and mine have mounted one of the most stunning comebacks on record.

All this is wonderful, and far more than we could have hoped for in January. But it’s no reason for complacency. In fact, a huge market rebound should put us on guard—because we don’t want to slip into the kinds of errors that would eat up a large chunk of our recent gains.

I recently saw a prediction by a well-known columnist that the blue chip stock indexes will soar another 20% or so—by February, no less! He’s not the only investor trying to convince himself that we’re in a V-shaped economic recovery.

A more realistic view would acknowledge that the overhang of consumer debt from the late binge will take several years to whittle down. Furthermore, the federal government has introduced significant distortions into the market (by using taxpayer money to purchase dodgy private debt, for example).

When these “stimulus” programs are curtailed, the economy’s true growth rate will reveal itself to be much slower than in the 1980s or 1990s. Reflecting this subdued outlook, stocks will fluctuate more erratically than they did in the glory years of 1982–2000.

[So,] look for investments with the right DNA to thrive in the months and years ahead. Focus on businesses that boast fortress-like balance sheets and entrenched franchises. Buy the stock only if it’s statistically cheap in relation to past and projected earnings, dividends, and similar benchmarks.

Bank of New York Mellon (NYSE: BK), one of the nation’s leading “trust banks,” earns most of its bread from fee-based services like securities processing and wealth management, rather than lending. As a result, BNY-Mellon largely escaped the [catastrophe] that engulfed the banking industry in 2008. In the years ahead, BK’s business, which doesn’t depend on credit expansion to the degree other banks do, will likely grow much faster than the industry as a whole.

Wall Street analysts expect BK to earn $2.42 per share next year, giving the stock a forward price/earnings ratio of a little [over] 11x. From 2003 to 2007, the stock traded at an average P/E of 17x. Thus, even if BK only bounces back to a 20% discount to its average valuation during the last bull market, the shares should appreciate 20% in the coming year.

BNY-Mellon didn’t really need any of the government’s TARP bailout money, [but it] accepted $3 billion, which it has since repaid. Bank of New York [also] agreed to cut its dividend—temporarily. I look for BK to restore its old 24 cents per share quarterly payout by late 2010 or early 2011. That would raise your cash yield to 3.6% on the current share price. Buy at $29 or less. (It traded above $27 Wednesday—Editor.)

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