Banks: Outperformance Is Still in the Cards


Stocks have opened down again today, with the Dow Jones Industrial Average and the broader S&P 500 losing about 0.3% each as of 10:10 a.m. EST.

Banks: Outperformance Is Still in the Cards
Financials had a banner year in 2012. They were the best-performing group in the S&P 500, with a 25% return. As the scars of the financial crisis continue to fade and investors become increasingly comfortable returning to the sector, financials could prolong their outperformance through 2013.

Valuation is no impediment to further gains. The S&P 500's financials sector contains 80 stocks -- 16% of the names in the index. However, when all the stocks in the index are ranked by their price-to-earnings ratio, the sector represents 30% of the names in the bottom quintile. Based on earnings-per-share estimates for the next 12 months, the financials' median P/E is 13.2, and the median price-to-book-value ratio is 1.18. Finally, some of the largest financials by market value sport the lowest valuations.

And there are catalysts. The two agreements announced yesterday to settle claims relating to mortgage loans in the aftermath of the credit crisis will mean a short-term hit to profits. The aggregate settlement amount is $20 billion, with Bank of America responsible for $14.1 billion. However, it removes huge uncertainty concerning a massive legal exposure that was hanging over the sector.

Yesterday was the deadline for the top 19 banks to submit their plans to the Fed for returning capital to shareholders as part of an annual round of stress tests. Citigroup has requested to carry out its first share repurchase since 2007, while JPMorgan Chase wants to raise its dividend and buy back shares. Bank of America has stayed mum on its plans, but comments CEO Brian Moynihan recently made to the Financial Times suggest the bank wants to return capital to shareholders, although they should not expect a large dividend increase or share repurchase.

Investors who already own bank shares can take heart; the recent run-up in bank shares needn't end in a hangover. For those who don't, there is still time to participate in the rehabilitation of the sector.

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Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him @longrunreturns. The Motley Fool owns shares of Bank of America Corp, Citigroup Inc , and JPMorgan Chase & Co.. 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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