Puerto Rican Banks a top pick.

In a commentary on how much bank stocks have run up in recent times, Sterne Agee analysts Todd L Hagerman and Robert Greene point out:

Banks

  • The Sterne Agee Bank index is up roughly 33% thus far in 2013, outperforming the broader market for the second consecutive year.
  • Since 2012, banks have returned a cumulative 73% price gain, versus a still healthy 44% gain for the broader market, which represents the best two-year stretch for the group since 1991-1992.
  • Additionally, 2013 marks only the fourth time in the last 24 years that every single constituent in the Sterne Agee Bank Index currently stands in positive territory for the year.

Given this stellar performance, how should you view banks as an investment in 2014, particularly now that the Fed’s QE taper has become a reality?

Quality and controversial names could be profitable

Quality banks, even if somewhat controversial ones, such as JPMorgan Chase & Co. (NYSE:JPM), present upside opportunity, and along with M&T Bank Corporation (NYSE:MTB), Citigroup Inc (NYSE:C) and PacWest Bancorp (NASDAQ:PACW) are top picks. M&A arbitrage, underlying potential balance sheet accretion or headline risk are other controversial angles included in Sterne’s picks.

“We suggest investors focus on names that offer attractive valuations, particularly leverage on the expense side, improving fundamentals, notably above-average loan growth and increasing capital returns. Accordingly, we would add to our basket names such as BB&T Corporation (NYSE:BBT), KeyCorp (NYSE:KEY), SunTrust Banks, Inc. (NYSE:STI), Wells Fargo & Co (NYSE:WFC), U.S. Bancorp (NYSE:USB),” say the analysts, qualifying that by saying that lower prices would provide safer entry points.

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Bank valuations and earnings growth

In Sterne’s view, large cap banks continue to offer upside value as they trade at 10-11x forward earnings and about 1.4x TBV, and this is after taking into account the bounce in valuations due to the ‘taper.’

However, keeping in mind the recent expansion in forward earnings multiples, the analysts say, “Essentially the magnitude and uniformity of price performance are likely unsustainable through what should be a fundamentally challenging 2014. We would expect fundamentals and execution to outperform in 2014, or a return to a stock picker’s premium rather than the prevailing “buy the group” that has been so prevalent the last couple of years.”

About 10-12% earnings growth in 2015E is currently factored into the Sterne Agee Bank index, and this appears logical given the improvement in the economy and higher yields.

Take a chance on down-and-out Puerto Rico banks

Beaten down Puerto Rico banks such as Popular Inc (NASDAQ:BPOP), First Bancorp (NYSE:FBP) and OFG Bancorp (NYSE:OFG) offer scope for appreciation, too, given that the economy of the commonwealth appears to have stabilized, at least in the near term. The analysts draw comfort from the recent Economic Activity Index prints as well as improving employment data.