Even though the financial sector has come a long way since the last recession, investors don’t seem to realize it. Banks have made immense progress in strengthening their balance sheets, but bank stocks are in steep decline, nearing levels not seen since the financial crisis.
Due to the collapse in commodity prices, loans that banks made to energy firms are deeply distressed. Investors are panicking that banks will lose huge amounts of money if these loans go bad. For the most part, banks have prepared for this with significant capital reserves, and they have only modest allocations to the energy sector.
Below, ETF Database discusses two big bank stocks that look attractively valued right now, as well as exchange-traded funds that would outperform if the financial sector rallies.
Cheap Bank Stocks to Buy
The first bank stock that investors should consider is Wells Fargo (WFC), which has the backing of none other than Warren Buffett himself. Berkshire Hathaway is Wells Fargo’s largest shareholder, holding more than 470 million shares. It is easy to see why Buffett has invested so heavily in the bank.
Wells Fargo’s earnings held up well last year throughout the downturn in the oil market. It earned $1.03 per share last quarter in diluted earnings on $21.6 billion in revenue. Analysts projected the bank to earn $1.02 per share on $21.8 billion. As a result, earnings beat expectations. The stock has declined, but this could be an excellent buying opportunity. Wells Fargo trades for 11 times forward EPS estimates and 1.4 times book value, and it pays a 3% dividend, which is an attractive yield level for income investors.
Another reason for investors to remain bullish on bank stocks is that they have strong balance sheets. Wells Fargo ended last quarter with a solid 10.7% Tier 1 ratio. Its allowance for credit losses as a percentage of total loans was 1.37% at the end of 2015, down from 1.53% in 2014.
Another Buffett favorite, U.S. Bancorp (USB) is also cheap right now. The stock trades for 10 times earnings and 1.7 times book value. U.S. Bancorp offers a dividend of 2.6%. The company grew diluted EPS by 2% in 2015 to a record $3.16 per share. Its provision for credit losses fell 7.9% last year, despite the downturn in the energy sector. It seems that big banks are still doing well, and are not overly exposed to the energy market.
How to Invest in Financial Sector ETFs
ETFs are a good option for investors who prefer a basket of bank stocks rather than investing in individual equities. ETF investors should consider the Financial Select Sector SPDR (XLF ). This is perhaps the most well-known ETF to invest in within the financial sector. Its largest holding is Wells Fargo, which constitutes approximately 8.5% of its total assets. Also, U.S. Bancorp is the ETF’s eighth-largest holding, representing 2.3% of the fund.
Another ETF is the Vanguard Financials ETF (VFH ). Again, Wells Fargo is its largest holding at 6% of assets, with U.S. Bancorp at 2% of holdings.
These ETFs should outperform the S&P 500 if the financial sector rises going forward. The major catalyst for this would be further increases in interest rates. Higher rates boost banks’ earnings power as they would be able to earn higher net interest margins. To find out why financials benefit during interest rate rises read Interest Rates and Financial ETFs. If the U.S. Federal Reserve stays on its path of interest rate hikes, these ETFs should outperform.
An even broader list of financial sector ETFs can be found here.
The Bottom Line
These ETFs should outperform the S&P 500 if the financial sector rises going forward. The major catalyst for this would be further increases in interest rates. If the U.S. Federal Reserve stays on its path of rate hikes, these ETFs should outperform. Higher rates boost banks’ earnings power, as they would be able to earn higher net interest margins.