Avoid This Classic Value Trap

Before you go, we thought you'd like these...
Before you go close icon

"Be fearful when others are greedy, and greedy when others are fearful." 
-- Warren Buffett

Nine times out of 10, I agree with Buffett.

However, given the magnitude and complexity of the eurozone crisis, I think the current fear in Europe's banking sector is quite warranted -- and I'd stay as far away as possible from the stocks listed below. Let me tell you how to avoid the classic value trap of these six stocks, and then give you one great financial sector stock that's actually worth buying today.

The typical trap you want to avoid
As value investors, often we look at crises as opportunities. We see stocks falling, P/E ratios lowering, and there is a natural inclination to look closer in order to find stocks at bargain basement prices. The eurozone crisis has presented such an opportunity.

For instance, if you're an average investor running screens for stocks that have taken a beating recently, that are trading at historical lows, and that have low valuations, you would probably end up finding some of the stocks below:

 

5-Day Price Change %

P/E Ratio

P/B Ratio

Bank of Ireland (NYS: IRE)

(11.7%)

N/A

0.06

Barclays (NYS: BCS)

(7.5%)

8.14

0.39

National Bank of Greece (NYS: NBG)

(5.9%)

N/A

0.19

BBVA (NYS: BBVA)

(4.7%)

6.69

0.75

Banco Santander (NYS: STD)

(3.3%)

6.79

0.67

HSBC (NYS: HBC)

(2.7%)

7.81

0.84

Source: Google Finance. N/A = not applicable due to negative earnings.

Each of the six banks above have fallen more than the Dow Jones (INDEX: ^DJI) over the past five days, and each are trading at seemingly ridiculously low prices. And some of them, most notably Banco Santander, have had a history of real success. In fact, I've pitched this as a great stock to own in the past for numerous reasons, including a strong balance sheet, great management, and a solid core tier 1 ratio.

Oh, how things have changed in the last few months, let alone the last year.

The problems are aplenty
Late last Friday, ratings agency Fitch warned that six of the eurozone economies could be hit with a credit downgrade in the near future, including the already embattled Spain and Italy. Fitch also surprised investors by saying it could cut AAA-rated France within two years. And then going for the jugular, Fitch concluded by saying that "a comprehensive solution to the Eurozone crisis is technically and politically beyond reach."

This matters because so far the European Central Bank, or ECB, has signaled that it is not willing to be the lender of last resort, providing a potential liquidity problem at the worst possible time. And if the countries mentioned above get credit downgrades, a vicious cycle could ensue where bond prices soar and debt becomes even more unmanageable to refinance.

Then there are the fiscal and financial problems of the eurozone. Sure, the EU Summit provided some detail for tighter fiscal restraints and accountability. How much of it will actually differ from the already useless Stability and Growth Pact is yet to be seen. But fiscal responsibility is only one aspect of the problem. Sanctions and discipline can only take these countries so far. Global competitiveness and growth is a necessity, and none of the countries in the eurozone seem to be able to balance the dynamic between moderate growth and tightening their purse strings.

And although the ECB has stated that it will accept higher-risk, assets-backed bonds as security for cash, in addition to lowering its reserve requirements for banks under pressure, it's not likely that these maneuvers will avert a credit crunch. Banks might get more money, but they are likely to sell assets, not make loans, which is what is really needed. Right now investors want to know European exposure on banks' balance sheets, so the chance that these banks take on more loans is dismal.

Of course, there are the political concerns involved in this calamity as well, which includes but is not limited to the possible extinction of the euro (it could happen!), the continued isolation of the U.K., and the inability of eurozone leaders to pass needed regulations that may be prevented by domestic political squabbling.

So where does this leave you?
Hopefully this leaves you far from wanting to invest in any European bank stocks. In fact, I'd normally be inclined to tell you to stay away from the global financial sector as a whole.

However, there's actually one bank that you could invest in today that could be a great way to continue having financial exposure, to invest in a small-cap stock, and receive an impressive dividend above 4%. Not only does this small bank generate gobs of profit (much more on a relative basis than the big-boy Wall Street banks), but it dominates its geographic industry and is a conservative player at a time when clearly that is not the latest fashion (I'm looking at you, MF Global).

If you're interested in hearing more about this outstanding investment, feel free to read The Motley Fool's brand NEW, special free report, "The Stocks Only the Smartest Investors Are Buying". Click here to access it, absolutely free!

At the time this article was published Jordan DiPietro owns shares of National Bank of Greece; clearly his head was not clear during that decision.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 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners