Identifying the best bank stocks by book value isn't as straightforward as it seems. That's not because it's hard to ascertain a bank's book value, but rather because not all investors are likely to agree on the definition of "best."
3 best bank stocks for enterprising investorsThe best bank stocks to an enterprising, or risk-seeking, investor are likely to be the ones with the most potential upside in the immediate future. In this case, the objective is to find ones that are trading for the greatest discount to book value.
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Three banks that come to mind are Bank of America , Citigroup , and Regions Financial . If you take the 20 biggest banks in the United States, excluding firms that focus primarily on investment banking, then these are the three cheapest, trading for 24%, 19%, and 17% below book value, respectively.
The investment thesis here is simple. Banking is a cyclical industry. When the economy is racing along, banks make a lot of money and their shares trade for generous premiums to book value -- generally, two times book value, if not more. But when the economy slows down, causing unemployment to soar and assets prices to plummet, banks see their revenue suffer and experience large loan losses. This causes the value of their shares to drop to one times book value, if not below that.
With this in mind, many bank stock investors will tell you that the best way to play these cyclical trends is to buy banks stocks when they're cheap, and then sell them when they're expensive. Thus, the age-old adage of bank investing: "Buy at half [of book value] and sell at two [times book value]."
This is precisely what Warren Buffett has done in the past. When banks were suffering from a downturn in the commercial real estate market in the early 1990s, he loaded up on shares of Wells Fargo, which has since become Berkshire Hathaway's largest passive investment in a publicly traded company. And in the latest crisis, he followed a similar strategy by investing $5 billion into Bank of America's preferred stock, with the option of buying 700 million shares of common stock for $7.14 each at any point before 2021.
3 best bank stocks for conservative investorsWhile the strategy of buying cheap bank stocks has undoubtedly paid off for the likes of Buffett, doing do isn't necessarily the best approach for the individual investor. This follows from the fact that banks are unusually risky, failing in droves every dozen or so years when the business cycle takes a turn for the worst. If you pick the wrong one, in other words, you could easily end up with a complete loss.
Given this, the conservative investor is likely to conclude that the "best" bank stocks are those with the greatest chance of both surviving and thriving in good times and bad. Three that come to mind are US Bancorp, Wells Fargo, and M&T Bank, all of which, as you can see in the table above, trade for healthy premiums to book value.
These three banks do two things in particular that allow them protect against the vicissitudes of the credit cycle. First, they focus on keeping their costs down, which leaves more revenue to cover loan losses in the future. And second, they have long histories of prudent risk management. Unlike the go-go lenders of the housing bubble, these companies generally steered clear of the riskiest, and ultimately the most costly, types of lending, such as interest-only and negative-amortization loans.
The net result is that these three bank stocks, while expensive, give investors the greatest change of producing industry-leading returns for decades ahead. They won't be the fastest growing stocks, but over the long-term they are positioned to generate the highest shareholder returns.
The article 6 Best Bank Stocks by Book Value originally appeared on Fool.com.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Capital One Financial., Citigroup Inc, Fifth Third Bancorp, Huntington Bancshares,, JPMorgan Chase, KeyCorp, PNC Financial Services, 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.
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