3 Bank Stocks With Huge Cash Flow

By Markets Fool.com

Continue Reading Below

While banks as a general rule have huge cash flows -- after all, they're in the business of buying and selling money -- some have bigger flows than others.

Cash flow at the nation's biggest banks
Over the last 12 months, the nation's three biggest banks -- JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), and Citigroup (NYSE: C) -- had positive free cash flows well in excess of $20 billion each. Citigroup led the way with $45 billion, followed by JPMorgan at $37 billion and Bank of America at $26 billion.

As you can see in the table below, these figures comfortably outpace most of the industry's other main players -- with the exception of Wells Fargo, which isn't far behind.

To appreciate just how substantial these cash flows are, consider this: There are only five companies in the United States that exceeded $20 billion in free cash flow over the past year.

Continue Reading Below

Apple, the world's largest company by market capitalization, led the way with a staggering $64 billion. Microsoft also made the cutwith free cash flow over the trailing 12 months of $26 billion. Beyond these, the list consists of banks.

But here's the thing: Only one of these banks is even remotely as profitable as Apple or Microsoft.

Over the same time period covered in the chart, Apple and Microsoft earned $47.8 billion and $20 billion, respectively. And although JPMorgan generated a net income of $22 billion, Bank of America and Citigroup both earned a mere $8 billion each.

The primacy of a bank's income statement
The disparity between these banks' earnings and their free cash flows shows that the latter is not as informative a metric for banks as it is for companies like Apple and Microsoft.

In the first case, both sides of most bank transactions are made in cash. Banks buy cash by taking deposits and sell it by making loans. Meanwhile, for most companies, only one side of a transaction is cash-based -- for example, an iPhone is exchanged for cash.

On top of this, when a bank makes a sale -- by underwriting a loan, that is -- it does so by dispensing cash, not receiving it.

Finally, because banks hold copious amounts of loans and securities that can increase or decrease in value whether or not they were bought or sold, events that don't involve cash -- such as a changes in interest rates from one day to the next -- can be just as important to a bank's profitability and survival as the ones that do involve cash.

This is why banks are one of the few types of companies for which the income statement is much more helpful than a record of cash flows in assessing financial performance.

As I've discussed previously, one of the metrics savvy bank-investors use to assess the current health and future vitality of a bank is the efficiency ratio, which derives from the income statement and measures the percentage of a bank's net revenue that's consumed by its operating expenses. The objective is to find banks with ratios that consistently fall near or below 60%.

Banks that operate efficiently not only leave a larger share of their revenue to distribute to shareholders, but they also have less incentive to loosen their underwriting standards in an effort to juice near-term earnings at the expense of higher default rates down the road. This is critical when you consider that, as famed bank investor Carl Webb puts it:"Banks get in trouble for one reason: They make bad loans."

There's no denying the importance of cash flow for any business, and these three megabanks' figures in that column sure look impressive. However, if you're in the market for a bank stock, then the income statement is the best place to start.

The article 3 Bank Stocks With Huge Cash Flow originally appeared on Fool.com.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Apple, Bank of America, and Wells Fargo. The Motley Fool owns shares of Apple, Bank of America, Citigroup Inc, JPMorgan Chase, and Wells Fargo. 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.