Financial assets - risk or opportunity?

13 Feb 2010

I am trying out a rather risky investment thesis by investing in financial stocks. I have begun to start building a position in the major financial stocks. I believe that the last few weeks have presented some good buying opportunities for financials. The three financial stocks that I have invested in are Wells Fargo, JP Morgan and Bank of America.

Wells Fargo is probably the best capitalized of the major banks. The recent addition of Wachovia has given Wells Fargo about 800 billion in deposits. Wells Fargo size is a major competitive advantage. They have a Tier 1 capital ratio and a solid balance sheet. Wells is currently the 2nd largest bank in the US in terms of market cap. Wells also has excellent management. Wells Fargo management have already accounted for a 74 billion dollar writedown of Wachovia’s total loan portfolio. This should reduce Wells exposure going forward. Wells stock has held up pretty well over the last few months compared to its peers. Wells has historically had a 22% profit margin and solid ROE of 18% over the last five years. It doesn’t hurt that Warren Buffett loves Wells Fargo and has owned it for years.

JP Morgan Chase should emerge from the financial crisis as the dominant player in the banking industry. JP Morgan got a steal with the acquisitions of Washington Mutual and Bear Stearns for well below their true value. JP Morgan has the largest deposit base of any bank in the country which gives it a strong capital base. JPM has solid management that has delivered an 18% profit margin over the past 5 years. The return on equity averaged 10.5%. I think this will increase in the future as Jamie Dimon and company realize the synergies of the Washington Mutual acquisition. JP Morgan currently sells well below its book value and pays a healthy dividend.

Bank of America is definitely the riskiest of the 3 banks. From its purchase of Countrywide just before the subprime crisis to its pending merger with Merrill Lynch, Bank of America has made some questionable moves. The Countrywide and Merrill Lynch deals that appeared cheap before now look severely overvalued. Bank of America’s shares have plummeted and this may provide an opportunity. The stock was selling for $10 recently which is well below its book value. Bank of America has historically averaged a 16% ROE and a 27% profit margin. I think that the Bank of America name is a major competitive advantage. Bank of America has a huge deposit base and the BOA name has significant goodwill. I think the Merrill Lynch acquisition will be a valuable brand for Bank of America long term. But I am not so sure about the Countrywide acquisition. Countrywide has a damaged brand name due to its heavy association with the subprime crisis. However, I do think with their ability to access capital and their strong brand name Bank of America will remain a viable entity.

These 3 stocks will probably continue to face difficult circumstances in 2009. I think that in the long run, these banks will benefit from the financial crisis and emerge with greater market share and strong financial structure.

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