Over the past year, the financial sector has been one of the best-performing areas of the stock market. In fact, while the S&P 500 has gained 13%, the financial sector has risen by more than 20%. Despite this high level of performance, there are many excellent financial companies that still trade for surprisingly low P/E ratios.
Temporary drama has created a bargain in this bank stock
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Wells Fargo has been one of the worst performers in the financial sector over the past year, down by about 1% while the sector is up more than 20%. If you follow the financial news, you know the main reason for the poor performance. The bank has been the subject of several scandals, including the infamous fake-accounts scandal, in which bank employees improperly opened as many as 3.5 million accounts over a period of several years.
However, Wells Fargo remains one of the most profitable banks in the U.S., with efficient operations and strong asset quality. Berkshire Hathaway is the bank's largest shareholder, and CEO Warren Buffett has repeatedly said he's not concerned with the bank as a long-term investment, calling the company a "terrific bank" and "an incredible institution." And thanks to some bad behavior, which should have a temporary effect on the bank's top and bottom lines, long-term investors can get in at a discount.
Despite recent issues, this bank's business remains solid
New York Community Bancorp has gotten absolutely crushed over the past couple of years, after a failed merger with Astoria Financial. The bank had made preparations for the merger, which included higher compliance expenses and a dividend cut, and it seems that investors have a general distrust of the bank's management as a result of the cancellation. As my colleague John Maxfield wrote, the bank made a pretty big mistake from which it has yet to fully recover.
Even so, the bank's core business remains solid. New York Community Bancorp's main business focus is lending on rent-controlled and rent-stabilized apartment buildings in New York City, which tend to have excellent tenant retention and minimal delinquencies. As a result, the bank's efficiency ratio is among the best in the sector, and default rates have been incredibly low, no matter what the market is doing.
To be clear, I'm disappointed in the bank's execution over the past couple of years, but I do believe the stock represents a compelling long-term value. And in the meantime, shareholders get a 5.7% dividend yield while they wait for the dust to settle.
Ridiculously cheap considering the growth potential
With about $9 billion in assets, BofI Holding is much smaller than the other two banks on the list. It is about one-fifth the size of NYCB and just 0.5% the size of Wells Fargo.
However, BofI is growing rapidly, which is the main reason I think it's a compelling investment at its current valuation. BofI, which stands for "Bank of Internet," reported annual earnings growth of 13%, and impressive 16% and 14% growth in loans and deposits, respectively. In addition, the bank is venturing into new areas of the business, such as auto lending and unsecured personal loans, and it also expanded its relationship with H&R Block to exclusively provide the tax preparer's refund anticipation loans. In a nutshell, there's still a lot of untapped growth potential.
Also, because of its online-only business model, BofI is one of the most profitable and efficient banks around. The bank's return on equity (ROE) and return on assets (ROA) are more than twice the industry's benchmarks, and total non-interest expense is less than half of the bank's peer group average, as a percentage of assets.
BofI is a relatively young company and is likely to be the most volatile of the three stocks discussed here, but it also has the highest reward potential if its growth story continues.
Just one piece of the puzzle
To be clear, a stock's P/E ratio is just one piece of the puzzle, and there are several other metrics that can be used in the valuation of stocks -- especially bank stocks. Price-to-book, price-to-tangible book, ROA, ROE, and efficiency ratio are just some examples of other useful metrics to take into consideration.
Having said that, a low P/E ratio can still be a good indicator that stocks are trading cheaply, and I believe that to be the case with these three stocks.
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Matthew Frankel owns shares of Berkshire Hathaway (B shares) and New York Community Bancorp. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and BofI Holding. The Motley Fool has a disclosure policy.
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