You may have heard that BB&T Corp. beat Wall Street expectations in the second quarter, posting earnings per share of $0.69.
You may be thinking that now is a good time to buy the bank since the second quarter was so positive. Before you do, take a quick moment with me to break down the company into the fundamentals that really matter. Your portfolio will be glad you did.
Beating the Street, impressive growth, and room to runIn the second quarter, BB&T posted some pretty impressive results. Earnings per share beat Wall Street expectations, return on equity was strong, and the bank was able to maintain a decent efficiency ratio even as it sold off an insurance unit and absorbed The Bank of Kentucky in an acquisition.
*Peer data from set of 60 comparably sized U.S. banks. Data provided by S&P Capital IQ. Dividend data from Yahoo!Finance. Data from Q2 2015 unless otherwise noted.
Kelly King, CEO of the bank, pointed out in the earnings call that excluding some non-cash costs related to the sale of a small unit within the bank, the bank's performance was actually even better. He said, "And if you exclude the American Coastal non-cash loss, our ROA was 1.17%. ROE was 9.06%, and importantly, our return on tangible common equity was 14.05%."
Including those expenses, return on assets was reported as 1.06%
BB&T is a relatively large bank, but not so large as to hinder its ability to grow. The bank closed on its largest acquisition this month,Susquehanna Bancsharesand finished absorbing the previously mentioned Bank of Kentucky in the second quarter. These investments are strong evidence that the bank can continue to grow at scale through M&A as well as through organic loan and deposit growth. Loans increased 3.9%, annualized, over the first quarter, and deposits grew 7.2%, annualized, for the same period.
The bank's annualized revenue growth rate is essentially flat, even though second-quarter revenue was up compared to both the 2015 first quarter and 2014 second quarter. The annualized data is skewed by the bank's strong performance in the 2014 fourth quarter.
The earnings look solid, but isn't there a ton of risk?In my view, the most important long-term factor in successful bank stock investing is understanding and assessing the risk a bank is taking onto its balance sheet. That means understanding its credit quality and its leverage ratio.
The top reason that a bank will lose money is making bad loans. When a loan goes unpaid, the bank is not just losing the interest income due with each missed payment but also the principal portion. Poor credit quality can destroy a bank with incredible speed.
Banks can mitigate this risk in a few different ways. Disciplined credit risk management is the best way to do this -- meaning the bank only makes loans to customers with strong cash flow, credit histories, and appropriate collateral. They can also supplement their loan business with fee income and other non-interest sources to diversify its income.
Because banks have such high leverage ratios, a relatively small loss can wipe out huge portions of its capital. The Basel III capital requirements have reined in the more egregious examples of excess leverage, but some banks still choose to take on more debt than others. These two factors together, credit risk and leverage, are what make banks so volatile through the business cycle.
BB&T's risk metrics look strong, with relatively low leverage and a low ratio of non-performing assets to total assets. Non-performing assets are loans that are significantly past due plus loans in foreclosure. The bank also has a healthy diversity in its income streams, with non-interest income representing nearly 44% of revenue for the second quarter.
*Peer data from set of 60 comparably sized U.S. banks. Data provided by S&P Capital IQ. Data from Q2 2015 unless otherwise noted.
From an investing standpoint, valuation is another risk factor that must be considered before buying any stock. A stock that trades on the cheap is less risky because there is a margin of safety built into that discounted price. If a stock is intrinsically worth more than what the market is asking, that cushion represents both your profit and a limited downside.
In the case of BB&T specifically, the stock trades slightly above the peer group average in terms of price to tangible book value. That adds some risk for the investor today. However, in light of the banks strong earnings, returns on assets and equity, and growth, it seems reasonable that the bank would command a premium valuation.
*Peer data from set of 60 comparably sized U.S. banks. Data provided by S&P Capital IQ.
Investors, here's what you are getting for your moneyFor investors today, BB&T represents a high-quality bank with strong fundamentals. With a valuation at two times tangible book value the bank is certainly not cheap, but I don't view it as overly expensive.
Earnings are strong, growth is healthy, and the bank's risk profile is better than peer. It's hard to ask for much more from a bank stock in 2015. An investor looking for a stable, long-term investment in the banking sector could do far worse than putting their money into this company.
The article This Regional Bank Does It Again originally appeared on Fool.com.
Jay Jenkins and The Motley Fool have 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.
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