Bill Miller must be a man who doesn't hold grudges. The once unbeatable fund manager lost quite a bit of his luster when a spectacularly bad bet he'd made on financial stocks helped send his famous Legg Mason Value Trust over a cliff during the market crash of 2008. Now, three years later, he's still clinging to the likes of Citigroup and Bank of America. Indeed, financial stocks recently accounted for 22 percent of the portfolio, compared with their 15 percent share in Standard & Poor's 500 index. Miller insists that the sector is a "bargain bin of values." Once the economy kicks into high gear, he predicts, bank profits will grow because "financials are the circulatory system of the economy."
So should anyone listen to him? Probably not, some experts would say, if he were going headlong into the Citis of the world alone. But Miller isn't alone: Some very successful managers, including Bruce Berkowitz (profiled in "World's Greatest Investors," on page 51) and David Ellison, president of FBR Fund Advisers, have also taken a shine to the sector -- buying up shares even as the banking industry has been pilloried by angry members of Congress, foreclosed homeowners and other groups. And yet, on the whole, the sector trades nearly as cheaply as it did during the financial crisis.
These three value managers -- pros who focus more on how cheaply valued a company is than on how fast its profits are growing -- have been stepping up as the crowd has clearly run away. The financial sector was the worst-performing group of the S&P 500 through the first five months of the year, down 8 percent. And the reasons for the flight seem clear enough: Banks, as a group, wrote off hundreds of billions of dollars' worth of bad debt from the housing crisis. A stagnant economy and high unemployment kept many households and businesses from taking out new loans. And questions over how financial reform may play out have only added to the uncertainty. (Congress passed the reform bill in 2010, but many of its regulations have yet to go into effect.)
Then again, such triple-whammy scenarios are the sort of thing that often makes value managers salivate. FBR's Ellison, who has followed the financial industry for over two decades, says there are good deals to be had across the sector. The best values, many experts say, are the four largest banks, which have tumbled 12 percent on average through June 1. Analysts say JPMorgan Chase and Wells Fargo, which collectively have more than $1.1 trillion in deposits, are further along in repairing their balance sheets and are ready to raise dividends or buy back shares.
The outlook is a bit cloudier, some analysts say, for Citigroup and Bank of America, both of which are still in recovery mode. Many investors were disappointed when the Federal Reserve rejected B of A's recent bid to raise its dividend. (A Bank of America spokesperson says the bank intends to submit a capital plan, which would include any possible dividend change, "at the appropriate time.")
Other pros like smaller financial firms. Erik Oja, an analyst at Standard & Poor's Equity Research, favors a few regional banks that "sailed through the credit crisis almost unscathed." A top choice: PNC Financial Services, a Pittsburgh bank that doubled in size when it bought rival National City. PNC, Oja says, has a good mix of consumer and business banking, plus a well-run asset-management division. He also likes the Dallas-based Comerica, which operates banks in several states.
There are even some opportunities, value managers say, in small community banks, an area beset by a rash of financial failures well after the market crash. The federal government has stepped in to close more than 200 small banks during the past 18 months. But the hard times have allowed some strong community banks to buy up assets on the cheap. Gregory Roeder, comanager of the $65 million Adirondack Small Cap fund, recently added Brookline Bancorp and FirstMerit to his fund. Brookline, a Massachusetts bank, is buying a competitor in Rhode Island, while FirstMerit, an Ohio bank, recently purchased some banks in Chicago. Roeder calls both firms "survivors."
Skeptics, of course, say there's another, more straightforward reason for the sector's low prices: Banks are not in great shape. Ed Yardeni, an independent investment strategist, says revenue can't grow much until home prices stabilize and more people get jobs. But that said, true believers are holding fast to the notion that when the sector does eventually turn around, it is likely to turn around on a dime. "Once GDP rises," Miller says, the share prices and dividends will improve, "and you want to be in there before that happens."
There's plenty of debate about the health of U.S. banks, but some analysts say there are bargains to be had in their stocks.
JPMorgan Chase (JPM)
Analysts say the megabank will earn nearly $5 a share this year, making the stock cheaper, on a valuation basis, than some of its weaker rivals. The firm is investing in itself too; it intends to buy back as much as $8 billion of its own stock in 2011.
Wells Fargo (WFC)
The lender, based in San Francisco, became a true national player when it snatched up Wachovia during the financial crisis. Analysts say it is the "low-cost producer" among the biggies, a key advantage when competitors are making loans at similar interest rates. Among the leading banks, analysts say, it could have the most room to increase its dividend.
More than half of this giant's revenue comes from abroad. It survived a near-death experience during the financial crisis (with the help of $45 billion in taxpayer money). Now, nearly three years later, Citi is trading at around 85 percent of its liquidation value, according to Chris Kotowski, managing director at Oppenheimer & Co. He calls the stock "remarkably cheap."
PNC Financial Services Group (PNC)
This regional outfit, headquartered in Pittsburgh, doubled in size after it bought up weaker rival National City, says Erik Oja, an analyst at Standard & Poor's Equity Research. Many banks have been raising profits considerably by reducing money they set aside for loan losses. PNC, however, has grown its profits in more sustainable ways, Oja says.
Valley National Bancorp (VLY)
The Wayne, N.J.-based community bank has a dividend yielding about 5 percent, making it appealing for income investors, says Jim Sinegal, associate director of equity research at Morningstar. He says that cautious lending habits have enabled it to turn a profit every quarter since the bank's founding in 1927.
This Akron, Ohio community bank has weathered the storm in an economically challenged region, says Gregory Roeder, a co-manager of $64 million Adirondack Small Cap fund, which owns the stock. Recently, the bank purchased some smaller Chicago banks. The jury is still out on that strategy, but analysts say that FirstMerit could benefit from expanding beyond slow-growth Ohio.
Brookline Bancorp (BRKL)
This Massachusetts bank wrote off a relatively small number of loans during the financial crisis. It is now in the midst of buying Bancorp Rhode Island, which Roeder calls "another solid bank that didn't lose money during the credit crisis." Brookling plans to issue new shares to complete the deal, which some analysts say could dilute the value of existing shares.