Bank stocks with low betas bring peace to your portfolio. Image source: iStock/Thinkstock.
Continue Reading Below
While bank investors should generally avoid technical stock trading metrics, there's one worth paying attention to: beta. Generally speaking, the best bank stocks right now have the lowest betas, including Wells Fargo , U.S. Bancorp , and M&T Bank .
*M&T's return on average common equity excludes expenses related to its merger with Hudson City Bancorp. Data source: Finviz.com and YCharts.com.
What's important to note here is the negative relationship between a bank's beta and its profitability. On one end of the spectrum are U.S. Bancorp, M&T Bank, and Wells Fargo, which have low betas but high profitability metrics. On the other end are Bank of America, Regions Financial, and Citigroup, which have high betas but low returns on equity.
Beta measures how much a stock moves on a typical day relative to the broader market. A beta above 1.0 means a stock moves more than the broader market. A beta below 1.0 means a stock moves less. And a beta that equals 1.0 means a stock generally moves in line with the broader market.
What the table above reveals, then, is that shares of U.S. Bancorp, M&T Bank, and Wells Fargo tend to be less volatile than the broader market, while shares of Bank of America, Regions Financial, and Citigroup tend to be more volatile than other stocks.
Common sense explains why this is. U.S. Bancorp, M&T Bank, and Wells Fargo are boring stocks. Sure, they're the best run banks in the country. And, sure, they've delivered the best shareholder returns over the long run. But they're consistent. Reliable. On a quarter-to-quarter basis, there's nothing to write home about. Just great returns, per usual.
But while these traits are appreciated by long-term investors, they're anathema to stock traders. Traders want action. They want earnings volatility. They want to be surprised. That's how they make (or lose) money. Consequently, they tend to avoid stocks like these.
Bank of America and Citigroup, on the other hand, offer the polar opposite of stability. Both of these companies came within a hair's breadth of failure during the financial crisis. And since then, both have struggled to generate consistent earnings. In Bank of America's case, its quarterly earnings since 2011 have fluctuated by an average of 66% over the prior-year period. Meanwhile, Wells Fargo's have grown at a consistent rate of 13.5%.
Data source: YCharts.com.
In sum, as Warren Buffett has said in the past, companies get the shareholders they deserve. Rock-solid companies that make great long-term investments attract people that want stability and consistency -- which explains their low betas. But companies that can't get their you-know-what together, attract investors that just want to make a quick buck from short-term volatility caused by earnings surprises.
The article Why Investors Should Generally Prefer Bank Stocks With Low Betas originally appeared on Fool.com.
John Maxfield owns shares of Bank of America. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short March 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America. 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 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.