Investors may be undervaluing bank stocks and sector-related exchange traded funds as a low interest rate environment and fears over litigation costs cloud people’s judgement.
“There’s tremendous amount of value in these stocks which is simply not being recognized by the market,” Dick Bove, Rafferty Capital’s vice president of equity research, said on CNBC.
Many financial and bank-related ETFs are trading a cheaper valuations, compared to the broader market. For instance, the SPDR S&P Regional Banking ETF (NYSEArca: KRE) has a 15.7 price-to-earnings ratio and a 1.3 price-to-book. The iShares U.S. Regional Banks ETF (NYSEArca: IAT) shows a 14.7 P/E and a 1.3 P/B. The PowerShares KBW Bank Portfolio (NYSEArca: KBWB) has a 13.4 P/E and a 1.1 P/B. The SPDR S&P Bank ETF (NYSEArca: KBE) is trading at a 15.8 P/E and a 1.2 P/B. Meanwhile, the S&P 500 index is hovering around a 18.4 P/E and a 2.6 P/B. [It’s About Time: Regional Bank ETF is Breaking Out]
Bove calculated that JPMorgan Chase (NYSE: JPM) has net cash per share of $148 but is trading at below $70 while Citigroup (NYSE: C) net cash per share stands at $70 but trades at around $55.
JPM makes up 1.6% of KBE and 8.4% of KBWB. C is 1.6% of KBE and 8.2% of KBWB.
Some observers have attributed to the underperformance in the financial sector to low interest rates as it has made it harder for banks to make money on deposits due to the near-zero rates. However, Rafferty research shows there is no correlation between interest rates and bank stock prices.
“It was almost impossible to see that there was a linkup between interest rates and what happened to bank stocks,” Bove said.
Additionally, many bank stocks weakened after litigation costs from the housing and financial crisis weighed on overall profits. However, Bove argued that the outlook has turned “somewhat positive” after the top 16 banks were charged about $300 billion in fines.
“The fines will still be there in the next five years, but they’re not going to be anywhere near what they were in the past five years,” Bove added.
Looking ahead, Bove pointed out that growth in loans could help support the industry. Total loan volume hit $8.25 trillion, led by lending to companies and commerce, and consumers could begin borrowing as the economy continues to expand.
“Driven by an increase in loans, you’re going to see earnings probably get back to $70 billion for the industry, and the stocks don’t reflect it at all,” Bove said. “You’re going to see a rotation into bank stocks, if nothing else, but the bottom line is you’re going to see a rotation into a group of stocks that are selling below their normal valuation and whose earnings are going to go up for at least the next two years.”
ETF investors are already shifting into bank stocks. For instance, KRE attracted $340.5 million in net inflows over the past month, IAT added $8.7 million, KBWB saw $110.4 million in inflows and KBE experienced $110.6 million in inflows, according to ETF.com.
For more information on the financial sector, visit our financial category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.