As stocks have raced back to near their all-time highs, banks are trading higher, but they still trade at relatively low valuations compared to their earnings power. Many of the largest banks trade for little more than 10 times earnings even as the S&P 500 trades for closer to 21 times earnings.
Here's why three Fool.com contributors picked JPMorgan Chase (NYSE: JPM), Toronto-Dominion (NYSE: TD), and Green Dot (NYSE: GDOT) as some of the best buys in the industry right now.
Bigger is better
Jordan Wathen (JPMorgan Chase): Large banks have shed much of last year's gains and are now worth a closer look. JPMorgan Chase strikes me as particularly attractive.
At the bank's recent investor day, JPMorgan Chase expressed cautious optimism about the bank's future, saying it has a focus on high-quality loans and expects a slower pace of growth. That would be concerning if not for the fact that JPMorgan Chase has grown its "core" loan book at a blistering compounded annual rate of 11% in the past five years, which is extraordinary for a bank that has close to double-digit market share in virtually every corner of the banking industry.
To be sure, this economic expansion is long in the tooth, but this isn't another 2007. Large banks, including JPMorgan Chase, have eliminated expenses, trimmed up their branch bloat, and turned their focus to the highest-quality credits that should sail through a brief recession with few losses. JPMorgan Chase indicated that it still believes it can earn a 17% return on tangible common equity over the medium term, driven in large part by its consumer and community banking unit, which houses its retail banking, card businesses, and branch network.
Given JPMorgan's high returns on tangible equity, it can continue to grow at an attractive rate while paying out a substantial portion of its earnings in dividends and buying back stock. At roughly 11 times last year's earnings and about 10 times what it could reasonably earn in 2019, the market is essentially valuing the bank as a lower-quality, no-growth bank. That's a mistake worth capitalizing on by taking advantage of a low valuation.
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Steady, plodding stocks win the lifelong race
Dan Caplinger (Toronto-Dominion): Many investors in the banking sector keep their eyes focused largely on U.S. financial institutions. That makes sense, given the complexity of dealing with international banking regulations and the various local practices and procedures that foreign-based banks have to follow. But the Canadian banking system shares a lot in common with how U.S. banks operate, and Toronto-Dominion gives investors a combination of Canadian and U.S. banking assets to generate profits on both sides of the border.
Toronto-Dominion is one of the biggest banks in Canada, and its exposure there spans the entire nation. That's generally been a good thing, because the Canadian banking system has been extremely solid, holding up far better than its U.S. counterpart during the financial crisis in 2008. Since then, concerns about overheating property prices in top Canadian markets like Vancouver have spawned fears of a housing meltdown, but Toronto-Dominion has been careful to manage risk and avoid overextending itself.
Meanwhile, in the U.S., the institution known here as TD Bank has spread down the East Coast and has its eyes on further expansion. The combination of U.S. and Canadian retail banking operations gives Toronto-Dominion some geographical diversification, and that's helped to keep the share price steadily rising. Add to that a dividend yield of around 3.5%, and Toronto-Dominion looks like a great bank stock to consider for your portfolio.
Lots of growth potential as we transition to a cashless society
First, Green Dot's core business is its banking products aimed at the underbanked. Just to name a few, Green Dot offers prepaid debit cards and non-traditional checking accounts under its GoBank brand name. I love this side of the business over the next decade or so -- it's undeniably getting less and less convenient to pay for everyday purchases with cash, and Green Dot's products are designed for the subset of the population that's most likely to still be using cash for most purchases.
In addition, Green Dot has a relatively young but rapidly growing "banking as a service," or BaaS, business. In simple English, it's not practical or convenient for most companies to become banks themselves, so Green Dot lets other companies offer banking products using their infrastructure, such as a prepaid debit product or person-to-person payment app. Just to name a couple, Apple and Uber are among Green Dot's BaaS customers.
Finally, thanks to so-so fourth quarter results, Green Dot is currently on sale -- down by nearly 25% since its earnings date -- and the stock now trades for 15.7 times forward earnings despite a double-digit earnings growth rate.
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Dan Caplinger has no position in any of the stocks mentioned. Jordan Wathen has no position in any of the stocks mentioned. Matthew Frankel, CFP has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.