Banking on Profits Down the Road

To say that bank stocks have been put through the ringer would be an understatement. As a result, many are rightfully staying away from the sector or even anything financial. While that is a good idea amid current conditions, a long-term investment strategy could greatly benefit by some exposure to banks.

Even though some banks have been beaten down by the credit crisis, one can still turn to industry stalwarts that should be strong enough to stand on their own during turbulent times and possibly lead the industry to a recovery from current bargain levels. Two bank giants in particular are weathering the credit crisis storm relatively well and have a layer of reinforcement around them in the form of the government’s Troubled Asset Relief Program, or TARP. These are JP Morgan Chase & Co. (JPM - Snapshot Report) and Wells Fargo & Company (WFC - Analyst Report).

JP Morgan Chase & Co. (JPM - Snapshot Report) is an industry leader in terms of market capital with about $97 billion under its belt. In addition to fending off some of the effects of the credit crunch, JPM was healthy enough to acquire a couple of the victims. The company bought Wall Street’s storied Bear Stearns at a deep discount. Subsequently, JPM acquired mortgage giant Washington Mutual, which was also a bargain and a boost to JPM’s total U.S. deposits.

While analyst estimates have declined as is the case for virtually all banks, earnings forecasts for JPM have seen narrower reductions than most others. For the 2009 year, analysts are expecting year-over-year earnings growth of 71%. The company delivered earnings per share that topped consensus estimates 4 times out of the past 5 consecutive quarters. JPM’s most recent surprise on estimates stands at an impressive 200%.

Earnings per share are expected to grow by 8% over the next 3 – 5 years, which is slightly higher than the industry average of 7%. JPM’s net profit margin of 12% is in line with the industry average.

Wells Fargo & Company (WFC - Analyst Report) is another giant in the in the industry with a market capital of approximately $81 billion. The company was able to get it hands on the majority of Wachovia’s assets, which also toppled under the weight of the credit crisis. This move will give WFC the most bank branches in U.S.

WFC has also seen earnings estimate revisions that dipped lower by narrower margins than what has been seen by most of the industry. The company’s earnings per share came in ahead of analyst expectations over the past 3 straight quarters. The average upside surprise during that time frame was 10%.

WFC earnings per share are projected to grow by 9% over the next 3 – 5 years, versus the industry average of 7%. The bank’s net profit margin of 13% is a bit higher than the industry average of 12%. WFC’s return on equity (ROE) of 14% tops the industry average of 10%.

The company is scheduled to release its fourth-quarter report on January 28.

Testing the waters with the aforementioned banks is a good way to start exposing one’s portfolio to a corner of the market that is poised for a robust recovery upswing. As economic conditions improve and the TARP program further stabilizes the banking industry, additional domestic banks will become more and more attractive.

Having stated that, I do want to stress that this approach is certainly not without risk and not for all investors, especially those who are managing a portfolio with a short-term time horizon.

Those who are ready and willing to venture into banks at discounted share prices can further diversify exposure to banks by adding a solid international pick to the duo discussed above. In the age of struggling banks, Mitsubishi UFJ Financial Group, Inc. (MTU - Analyst Report) offers outstanding fundamentals.

For the fiscal year ending March 2009, analysts hiked earnings estimates by an astonishing 126% during the past month. For the following fiscal year, earnings forecasts increased by 51% over the past 30 days. Analysts are looking for year-over-year earnings growth of 92% for the year ending March 2010.

The Zacks #1 Rank (“strong buy”) name is set to report next on February 5.

Again, it is important to remember that the 3 banks are not necessarily “get rich quick” plays and should be considered a risky component of one’s overall asset allocation strategy. However, investors who take advantage of today’s bargain share prices stand to be handsomely rewarded over the long-term.

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