Benefit Trifecta for Five Major Bank Stocks
This week, I use AAII’s A+ Stock Grades to give you insights into five major bank stocks poised to benefit from the financials sector’s trifecta of positive events: vaccine rollout, stock buybacks and one-party political control. For investors focused on a solid economic recovery, major bank stocks Bank of America Corp. (BAC), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM), Morgan Stanley (MS) and Wells Fargo & Co. (WFC) may be the place to cash in.
Banking on an Economic Recovery
There have been three positive events over the last few months that have put major bank stocks on the road to pre-pandemic returns. On November 9, 2020, Pfizer and BioNTech first announced that their coronavirus vaccine candidate was found to be more than 90% effective in a phase-three trial. Since this announcement, additional developments on both Pfizer’s vaccine and a vaccine from Moderna have revealed even greater efficacy. Both were eventually approved for use by the U.S. Food and Drug Administration (FDA).
Earlier last year, the Federal Reserve suspended banks from buying back shares and placed restrictions on dividends. However, on December 18, 2020, the Fed said that banks, starting in the first quarter of 2021, would be allowed to restart share repurchases. The Fed said that share buybacks and dividends would be “limited to an amount based on income over the past year.”
Longer-term Treasury yields began the year moving significantly higher, with the U.S. 10-year Treasury yield rising above 1% for the first time since March 2020. Yields rose after Democrats won control of the Senate, winning both runoff elections in Georgia, as the market priced in more economic stimulus and higher inflation. By winning Georgia’s Senate seats, the Democrats’ control of the Senate is only by the slimmest of margins. Senate seats are split 50–50 along party lines, with vice president Kamala Harris serving as the tiebreaker for simple majority votes.
Yields can rise for a few reasons, but the most important are expectations that growth and inflation will start to rise. The 10-year yield is a benchmark for consumer interest rates on mortgages, credit cards and student and auto loans.
The idea that the underlying economy is in decent shape complements what’s shaping up to be a “fiscal goldilocks” scenario: a divided government that’s capable of pushing through additional emergency fiscal support while being unable to advance tax policy seen as inhibiting growth in the corporate sector. In fact, following the results of Georgia’s runoff elections on January 5, economists across Wall Street boosted their forecasts for GDP growth in 2021.
Bank stocks were pummeled by the coronavirus pandemic in 2020, as concerns over loan repayments pushed most major banks to increase their provisions for loan losses. With the vaccine rollout underway, share repurchases starting again and more stimulus spending leading to a steepening yield curve, the banks are hoping that the first quarter of 2021 and beyond will prove to be a turning point.
Grading Leading Bank Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes how attractive five major bank stocks — Bank of America, Citigroup, JPMorgan Chase, Morgan Stanley and Wells Fargo — are based on their fundamentals.
What the A+ Stock Grades Reveal
Bank of America is one of the largest U.S.-based financial holding companies, with a presence in consumer and commercial banking, investment banking, trading and wealth management.
Bank of America has a Value Grade of A, based on its score of 16, which is considered deep value. The company’s Value Score ranking is consistent across several traditional valuation metrics, with a score of 34 for the price-earnings ratio, 26 for the price-to-book-value ratio and 24 for the price-to-free-cash-flow ratio (remember, the lower the score the better for value). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-to-sales ratio, enterprise-value-to-EBITDA (EV/EBITDA) ratio and shareholder yield.
With short-term interest rates still pinned to near-zero by the Fed, banks that borrow short and lend long hope that higher longer-term rates will improve margins in 2021. Net interest margins, a key measure of interest collected on loans minus interest paid on deposits, fell considerably over the course of 2020.
Among the large U.S. bank stocks, Bank of America is the most centered on the U.S. economy. CEO Brian Moynihan said last year that the bank’s third quarter would likely “be the bottom” for declines in its net interest income.
Estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. Bank of America’s Estimate Revisions Grade is B, which is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Bank of America has posted earnings surprises of 3.4% and 38.6% for its last two fiscal quarters, mainly due to positive contributions from its equity trading group.
In addition, over the last month, the consensus estimate for the fiscal year ending December 31, 2020, has risen 7.9%, while it has increased 14.4% in the previous three months. Over the last month, there have been 15 upward revisions to the fiscal-2020 estimate and one downward revision.
JPMorgan Chase is one of the largest global financial services companies, with nearly $3.5 trillion in assets and operations around the globe. The company is organized into four major segments: consumer and community banking, corporate and investment banking, commercial banking, and asset and wealth management. The company has strong fixed-income and equity trading businesses.
JPMorgan Chase has a weak A+ Growth Grade of D. The Growth Grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow.
JPMorgan Chase has exhibited weak growth over the past year. Sales decreased 30.4% year over year for the quarter ending September 30, 2020, while operating cash dropped nearly 184%. However, the company managed to boost earnings by 9%.
The company has a Momentum Grade of C, based on its Momentum Score of 47. This means it ranks in the middle of the pack of all stocks in terms of its weighted relative strength over the last four quarters. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters.
AAII’s A+ Stock Grades for JPMorgan Chase are expected to improve as the company just reported excellent fourth-quarter 2020 earnings. These updated results will be incorporated into the A+ Stock Grades this week.
According to Morningstar, the biggest swing factor was provisioning for credit losses. In the fourth quarter, JPMorgan Chase was able to release almost $3 billion in reserves compared with net charge-offs of only $1.1 billion, resulting in a positive effect on the income statement of $1.9 billion. Compared with credit costs of roughly $600 million last quarter, this was a roughly $2.5 billion swing in earnings. In addition to solid provisioning, JPMorgan Chase also delivered robust fee income for investment banking, trading, asset management and mortgage fees.
Wells Fargo is one of the largest banks in the U.S., with approximately $1.9 trillion in balance sheet assets. The company is split into three segments for reporting purposes: community banking, wholesale banking, and wealth and investment management. The community banking segment serves consumers and small businesses with products including deposit accounts, credit and debit cards and student, mortgage and home equity loans. Wholesale banking includes corporate and commercial real estate lending, asset-based lending and trade financing and capital markets businesses. Wealth and investment management includes advisory, brokerage, retirement and trust services. The majority of Wells Fargo’s lending takes place in the U.S.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher Quality Grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
The Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
Wells Fargo has a Quality Grade of B, putting it near the top tier among all U.S.-listed stocks. The company ranks highly in terms of its buyback yield, ranking in the 95th percentile of all U.S.-listed stocks, but only average in terms of return on assets, ranking in the 52nd percentile.
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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