There is plenty of opportunity in the financial sector, with many banks earning huge profits and trading for historically low valuations. However, not all banks are good investments right now. Here are two bank stocks I strongly suggest investors avoid and one that is an exceptional buying opportunity right now.
Continue Reading Below
Exposure to unstable economies
Right now, I would definitely avoid bank stocks with a lot of international exposure, particularly to countries whose economies are relatively unstable.
One good example is Banco Santander , which has operations in many parts of the world (including the United States) but does most of its business in Spain and Brazil. The company looks tempting on the surface with a dividend yield of more than 11% and a valuation of just 89% of its book value. However, this is one example of a bank stock that's cheap for a reason.
The eurozone is weak right now, and Brazil is one place you really should avoid, given its slumping economy and the high-profile bribery scandal embroiling national oil company Petrobras. If that weren't enough, Moody's recently downgraded Brazil's sovereign debt and dropped the outlook for the country's banks to negative.
Another reason to avoid Santander is its dilutive dividend policy. Because the bank doesn't earn enough to cover its dividend -- and hasn't in quite some time -- it pays most of its dividends in stock, rather than cash. This effectively reduces the value of existing shares, and it amounts to giving shareholders some of their own money (rather than profit) in the form of dividends.
Lastly, in the Federal Reserve's most recent round of stress tests on some of the largest banks operating in the U.S., Santander was one of just two banks to have its capital plan rejected.
Continue Reading Below
Rising expenses and lots of oil exposure
Another bank stock I would avoid right now is Cullen/Frost Bankers .
First off, there are plenty of reasons to like Cullen/Frost. The bank's loan portfolio has high credit quality, and the company has an impressive history of growth and profitability in any economic environment. It even remained profitable throughout the financial crisis. So, unlike my other bank to avoid, this one is actually quite stable and profitable.
However, there are a few negatives to consider. For starters, the bank's noninterest expenses (salaries, regulatory compliance expenses, etc.) have grown faster than its revenue in three out of the last four years. Further, I have to worry about the bank's ability to continue to grow its loan portfolio given the recent plunge in oil prices. Of course, this has affected most banks in one way or another, but because most of Cullen/Frost's operations are in Texas, it could be affected more than most.
Finally, I simply think Cullen/Frost is too highly valued right now. There are other banks with similar business models and asset quality that trade much more cheaply. In a nutshell, Cullen/Frost is an excellent, well-run bank, but now is not the time to buy.
Cheap, but for how long?
One of my favorite bank stocks right now is Toronto-Dominion Bank , or simply TD Bank, as it is known to most consumers.
I love TD Bank because of its relatively low-risk business model, which is focused on retail banking in Canada and the U.S. About 80% of TD's earnings come from retail banking, and the company is one of the best in the business at it. Known as "America's Most Convenient Bank," TD isn't putting as much emphasis on online and mobile banking as its competitors. The bank does indeed offer those services, but it prides itself on its face-to-face customer service and its convenient hours, which include evening and Sunday hours in most markets. TD has been very successful at attracting customers who don't want their banks to keep "banker's hours."
And the reason I love TD now is that shares have gotten a lot cheaper lately. There are several reasons for this, including the strong U.S. dollar (remember, much of TD's operations deal in Canadian dollars) and falling oil prices. In fact, TD's share price has dropped by about 15% in the last six months.
However, there's nothing wrong with TD's business itself. The bank is one of the few in the world to be rated Aa1 by Moody's, and it was named the "Best Big Bank of 2014" by Money magazine. TD is trading at a discount due to temporary issues, and now may be a good time to take advantage.
These are plenty of fish in the financial sea
Bear in mind that this is by no means an exhaustive list. There are several other bank stocks that are good buys right now -- and plenty of others that investors should avoid. My point is that you should do your homework before deciding to buy or sell any stock. If you do that, you'll be well on your way to a rock-solid portfolio.
The article Bank Stocks: 2 to Avoid, 1 to Buy originally appeared on Fool.com.
Matthew Frankel owns shares of The Toronto-Dominion Bank (USA). The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.