Is This Bank Cheap According to Graham?

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I recently spent some time dissecting The Intelligent Investor, the seminal book on value investing. Along the way, I talked about the Graham number as a means of valuation when it comes to stocks. The formula is pretty straightforward: Multiply earnings per share by book value per share, then multiply that by 22.5, and finally take the square root. The result, in dollars, is the Graham number.

However, a quick check can help determine whether a company might be worthy of a look using the teachings of Graham. He said that in an ideal situation, the P/E ratio and P/B ratio multiplied together should not exceed 22.5, with a maximum P/E ratio of 15 and P/B of 1.5. With that in mind, I screened the stocks of the S&P 500 that met those requirements and was presented with 56 companies. I will be making a CAPScall on most of these companies after comparing them to competitors and their current value in relation to their Graham numbers. Up next is money center bank KeyCorp (NYS: KEY) .

Who are they?
KeyCorp is a Cleveland-based bank, offering community banking services in 14 states under the KeyBank name. They joined megabank JPMorgan Chase and 13 other banks in passing Federal Reserve stress tests on Tuesday, announcing a $344 million share buyback, causing its share price to rise over 5% from Monday's close. It publicly opposed the Volcker Rule requirements on banks, stating that they would place an expensive burden on smaller banks. Nevertheless, while it isn't a holding of Berkshire Hathaway's portfolio, it does share some of the characteristics of what Warren Buffett looks for when investing in companies.

What's it worth?
When compared to other financial companies of similar market cap, it is among the cheaper banks, including previously profiledHuntington Bancshares (NAS: HBAN) :

Company

EPS (TTM)

Book Value Per Share (MRQ)

Graham Number

Recent Price

KeyCorp$0.87$10.09$14.05$8.26
Comerica (NYS: CMA) $2.09$34.81$40.46$31.76
New York Community Bancorp (NYS: NYB) $1.09$12.73$17.67$13.27
Huntington Bancshares$0.59$5.82$8.79$6.09
SLM (NAS: SLM) $1.18$9.20$15.63$16.57

Source: Yahoo! Finance and author's calculations.

Only SLM, better known as Sallie Mae, currently trades above its current Graham number. Quarterly earnings for the education lender were down slightly from the same period in 2010, but a healthy dividend yield near 3% make it a popular pick in a well-known hedge fund. Comerica rode record deposits to a strong 2011, returning 47% of income to shareholders through dividends and share buybacks. New York Community currently sports one of the higher dividends in the banking industry, with a yield approaching 8%. Huntington Bank currently yields a modest 2.7%, but has room to grow its dividend, making it a favorite among banks.

Accountability time
As another smaller bank with some room to grow, KeyCorp joins Huntington Bancshares and Fifth Third Bancorp as a bank that will continue to improve along with rest of the financial sector. Therefore, I will be placing a thumbs-up over on my CAPS page in order to track this call and keep myself accountable. I will also be adding KeyCorp to My Watchlist to stay up to date on anything that may cause me to change my opinion of the company.

KeyCorp may not be the only opportunity to profit off of smaller banks. Many investors are interested in bank stocks, including Warren Buffett himself. Our special report "The Only Stocks the Smartest Investors are Buying" explains why Buffett would buy one bank in particular were he a smaller investor. Click here to get your free copy today.

At the time this article was published Fool contributor Robert Eberhard owns shares in Berkshire Hathaway. Click here to see his holdings and a short bio or follow him on Twitter. The Motley Fool owns shares of JPMorgan Chase, Huntington Bancshares, Key, Berkshire Hathaway, and Fifth Third Bancorp. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. 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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