This Overlooked Sector Is On The Move
Recent market volatility has made finding actionable stocks harder than at any other time since the Great Recession. And with the CBOE Volatility Index (VIX) hovering around 20, there isn’t any reason to suggest that market volatility will decrease markedly anytime soon.
Which begs the question…
#-ad_banner-#Should investors with risk capital to deploy stay on the sidelines until the VIX returns to a more comfortable level? Or can investors deploy their capital in safe and effective investments?
The answers to these questions are easier than you might think. You see, despite market volatility, corporate profits are expected to have risen 17% since the first of the year. That bodes well for the market as a whole.
But it doesn’t mean investors should just pile into the same stocks they’ve been pushing higher for the better part of a decade. Because, believe it or not, there are some economic sectors that haven’t been pushed to the limit of prudent valuations.
One such segment is regional banks. With the recently enacted tax cuts, rising interest rates, and the tailwinds of robust economic growth, regional banks are finally in the economic sweet spot. At present, analysts’ expectations for financial earnings have risen to more than 25%. Energy is the only sector with a higher upward revision in earnings.
Clearly, bank stocks are on the move. But, that number shouldn’t make investors think any regional bank stock will do. Investors must understand that not all bank stocks are created equal. And the rising tide in the sector will lift some stocks more than others.
One such bank is Cincinnati-based Fifth Third Bank (Nasdaq: FITB).
As you can see from the chart above, FITB shares have risen more than 40% in the past 12 months. And there’s good reason to believe this outperformance will continue well beyond 2018. In fact, it’s likely we’ll see acceleration from here.
Since the Great Recession, government regulation of banks was a major impediment to growth. But that’s about to change drastically. The Republican-controlled Congress has made reduced bank regulation a cornerstone of their agenda. And as the number and scope of financial regulations decline, banks will save billions annually on compliance costs.
But there’s more. By combining the saving from less regulation to higher interest rates from the Federal Reserve, banks are on the receiving end of a double-barrel blast. You see, while higher interest rates mean higher interest expenses on personal and corporate debt, banks charge higher interest on these loans. As a result, lenders will see additional revenue for the next several years as the Federal Reserve continues to normalize rates.
There’s more to Fifth Third than great tailwinds. The company is firing on all cylinders, and while the stock isn’t cheap by historic standards, there are compelling reasons the stock makes for a good buy.
Fifth Third trades at a price/earnings (P/E) ratio of just 12.4. Now that might be impressive, but in all honesty, P/E ratios aren’t the best financial metric to use for banks. A better guide is the price to book ratio (P/B). FITB’s P/B ratio is 1.49. That’s a significant discount to the S&P 500 Index average of 3.17.
Other important metrics for banks are return on assets (ROA) and return on equity (ROE). Historically, analysts want to see ROAs of about 1% and ROEs of greater than 10%. These are considered solid performance numbers.
So where does Fifth Third bank rate on these important metrics? FITB’s ROA is a hefty 1.49 — a nearly 50% premium over the baseline. Its ROE is impressive, too. Currently, the company’s ROE is 14.17 — a 47% premium to its baseline value.
The bank saw its revenues in 2017 grow from $6.2 billion to $6.9 billion — an 11.6% increase. The company’s net income grew to $2.2 billion over the same period — a 40% increase over 2016.
The company’s projected EPS growth is roughly 7.5%. Using this information to put a forward value on the stock, we should expect shares of Fifth Third to rise to $43/share in the next 3-5 years. Should the stock’s P/E ratio normalize as expected, a price of $52.50 or higher is appropriate.
Best of all, while we’re waiting for the stock to rise, investors can look forward to a dividend with a yield of about 2%. Of course, the dividend will increase going forward. Earnings tailwinds from higher interest rates combined with a very low dividend payout ratio of 21% means the dividend can only go higher from here.
Fifth Third stock isn’t a screaming value play today, but for investors looking for a safe investment with potential for big gains, FITB is a stock that should be deposited into a portfolio.
Risks To Consider: The one thing that could hurt FITB shares is also the thing pushing the stock higher. That is, higher interest rates. Of course, banks are benefitting from higher rates, but if the Fed makes a mistake in pushing rates too high too soon, the economy could easily descend into recession. This would crush all bank stocks.
Action To Take: Buy shares of FITB up to $34 per share. Use a hard stop of $25 to protect your capital. Expect to hold shares of FITB for the medium term of up to five years. Mitigate your risk by applying no more than 3% of your portfolio to shares of Fifth Third.
Editor’s Note: Want more stocks like FITB? Try our Top 10 Stocks for 2018.
Stock #2: lets you own a stake in every Hollywood movie and yields 12.6%
Stock #3: has higher profit margins than 98% of all companies on the S&P 500.
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