U.S. investment banks have been much favored by investors because of the far-reaching benefits that rising rates, increasing trading activities, investment banking business momentum and record IPOs could bring to the industry. While the first half of 2018 failed to display impressive results due to trade-war fears and geo-political tensions, the expected future benefits have been helping investment banks outperform the broader market since mid-2016.
M&A activities were strong in the first half of this year with the execution of many large transactions. Steady economic growth and low interest rates in the emerging economies along with growth in corporate earnings on tax reforms are likely to keep the momentum alive in the quarters ahead. Although trade-war worries and higher interest rates in the United States can undermine this growth curve, M&A deal volume is anticipated to accelerate.
Moreover, steadily growing IPO activities experienced since the beginning of this year are expected to continue, driven by favorable equity markets and decent corporate earnings. In fact, improved investors’ confidence in the stock market might create a solid IPO pipeline in the quarters ahead.
These factors might lead to solid investment banking revenues for the industry participants. Equity underwriting fees are projected to increase and a potential rise in fees from growing M&A activities in some sectors could result in higher advisory fees.
However, debt underwriting fees may not be a good support, as rising rates in the United States will limit corporates’ involvement in these activities.
Nevertheless, uncertainty-induced instability might continue for some time, which will keep supporting the trading business. Further, with the continued increase in interest rates, investment brokers are expected to earn more on the un-invested cash in their customer accounts.
Furthermore, innovative trading platforms, investments in technology and advertising are expected to enhance the overall backdrop for investment banks.
Attractive Stock Market Performance
Looking at the group's market performance over the past two years, it appears that the broader economic recovery has been helpful to industry participants. The gradual improvement in the trading environment, a favorable investment banking backdrop and policy changes were other factors encouraging investors to bet on investment banks and brokers.
The Zacks Investment Bank Industry, a 22-stock group within the broader Zacks Finance Sector, has outperformed both the S&P 500 and its own sector over the past two years.
The industry has struggled lately, but it has done very well when we look at a longer time horizon. Over the last two year period, the stocks in this industry have collectively gained 69.6%, handily outperforming the Zacks S&P 500 Composite and Zacks Finance Sector's 29.3% and 28.3% gains, respectively.
Two-Year Price Performance
Investment Bank Stocks are on Sale
Despite outperforming the industry in the past two years, the industry’s valuation looks inexpensive. One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is the most appropriate multiple for valuing finance companies because of large variations in their earnings results from one quarter to the next.
This ratio essentially measures a bank's current market value relative to what it would be worth if all assets were sold, debt was paid and intangible assets were written off.
The industry currently has a trailing 12-month P/TBV ratio of 2.69X, slightly above the median level of 2.57X, over the past two years. The industry has traded as high as 3.31X and as low as 1.69X over the last two years.
The space looks attractive when compared with the market at large, as the trailing 12-month P/TBV ratio for the S&P 500 is 10.07X and the two-year median level is 9.17X.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a lower P/TBV ratio, comparing investment banks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with its broader sector tally ensures that the group is trading at a decent discount.
The Zacks Finance Sector’s trailing 12-month P/TBV ratio of 2.76X and the median level of 3.48X for the same period are above the Zacks Investment Bank Industry’s respective ratios.
Price-to-Tangible Book Ratio (TTM)
Outperformance May Continue on the Improving Earnings Outlook
Prospects of profitability with rising interest rates, increase in volatility-driven trading income, investment banking business momentum and other strategic initiatives should help investment bank stocks continue generating solid shareholder value going forward.
But what really matters to investors is whether this group has the potential to continue outperforming the broader market in the quarters ahead. Investors may consider the current price levels as good entry points as there are convincing reasons to predict a decent upside in the near term.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the estimate revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry below shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. While estimates for this year and next have been stable lately, they did come down a fair amount earlier.
Price and Consensus: Zacks Investment Bank Industry
The industry's earnings outlook becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $3.16 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Investment Bank industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $3.16 'per share' of the industry for 2018, but how this dollar number has evolved recently.
Current-Year EPS Estimate Revisions
As you can see here, the $3.16 'EPS' estimate for 2018 is up from $3.04 at the end of March and $3.03 at the end of the month period to that and $2.63 this time last year. In other words, the sell-side analysts covering the companies in the Zacks Investment Bank industry have been raising their estimates.
Zacks Industry Rank Indicates Solid Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.
The Zacks Investment Bank industry currently carries a Zacks Industry Rank #57, which places it at the top 22% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has remained in the top half of the rank list over the past eight weeks.
Investment Banks Promise Long-Term Growth
The industry possesses solid long-terms prospects as well. The group’s mean estimate of long-term (3-5 years) EPS growth rate has been mounting since February 2018 to reach the current level of 15.94%. This compares favorably with the Zacks S&P 500 Composite’s figure of 9.8%.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-term EPS growth could be the top-line recovery that the industry participants have been showing since the beginning of 2017.
Another important indication of a solid long-term prospect is the improvement in the group’s return on equity (ROE), which is a key metric for evaluating finance stocks.
One should particularly consider betting on investment bank and broker stocks that depict an upbeat earnings outlook.
5 Investment Bank Stocks to Bet on
Evercore Inc. (EVR - Free Report) : The stock of this New York, NY-based bank has gained 50.1% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 2.7% upward over the last 60 days. The stock currently sports Zacks Rank #1 (Strong Buy). (You can see the complete list of today’s Zacks #1 Rank stocks here)
Price and Consensus: EVR
Greenhill & Co., Inc. (GHL - Free Report) : The consensus EPS estimate for this New York, NY-based bank has moved 6.8% higher for the current year, over the last 60 days. This Zacks Rank #1 stock has rallied 47.9% over the past year.
Price and Consensus: GHL
Interactive Brokers Group, Inc. (IBKR - Free Report) : The stock of Greenwich, CT-based bank has risen 61.8% over the past year. The consensus EPS estimate for the current year has been revised slightly upward over the last 60 days. The stock currently carries a Zacks Rank #2 (Buy).
Price and Consensus: IBKR
The Charles Schwab Corporation (SCHW - Free Report) : The stock of this San Francisco, CA-based bank has gained 16.1% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised slightly upward over the last 60 days. The stock currently carries a Zacks Rank #2.
Price and Consensus: SCHW
LPL Financial Holdings Inc. (LPLA - Free Report) : The consensus EPS estimate for this Boston, MA-based bank has moved 4% higher for the current year, over the last 60 days. This Zacks Rank #2 stock has rallied 54.2% over the past year.
Price and Consensus: LPLA
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