The financial sector has been one of the best-performing areas of the market over the past few years, but there's reason to believe that the group could continue to outperform. Here's why these financial sector specialists think Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), and Goldman Sachs (NYSE: GS) could be smart buys right now.
This bank has performed extremely well, but could be just getting started
Matt Frankel (Bank of America): Bank of America has been one of the best-performing stocks in a hot financial sector, nearly tripling since early 2016. However, the important thing to realize is that the gains are well justified by the bank's performance, and there are some positive catalysts that could boost profits even more.
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Bank of America has become a much more disciplined and profitable institution in recent years. The efficiency ratio of Bank of America's consumer banking division has improved from 61.1% in 2014 to 49.6% today, while client satisfaction scores have improved dramatically. While credit card charge-offs are up industrywide, Bank of America's are a full 100 basis points below its peer group average (3.02% vs. 4.02%), a sharp reversal from before the financial crisis.
The bank's growth has been extremely impressive as well. Over the past three years, the bank's consumer loan and deposit portfolios have grown by 14% and 26%, respectively, handily outpacing peers.
Going forward, the bank is in a great position to take advantage of rising interest rates, with a relatively high proportion of noninterest-bearing deposits. In fact, Bank of America estimates that a 100-basis-point parallel shift in the yield curve would result in $3.3 billion more net interest income over 12 months.
Finally, Bank of America has emerged as a leader in mobile banking and other banking technologies, which should help to continue to improve efficiency and revenue going forward. For example, the bank's new digital mortgage experience launched just two months ago and has tripled the bank's digital-sourced mortgage applications. And, nearly one-fourth of the bank's deposit transactions now come from cost-efficient mobile apps. Trends like these could have a serious impact on the bottom line going forward.
Everyone hates this bank, so I love it
Jordan Wathen (Wells Fargo): After opening millions of fake accounts, charging customers insurance premiums that were too high, and paying a $1 billion fine to regulators for its behavior, Wells Fargo customers are so upset with the bank that they kept $1.3 trillion of deposits in their accounts last quarter.
No one wants to hear it, but perhaps the best indicator of a durable competitive advantage is that a company can keep most of its customers in spite of an onslaught of negative headlines.
Wells Fargo's sticky depositors are what make it a gem, as the best banks are differentiated by the quality of their liabilities rather than the quality of their assets. Wells Fargo pays about 0.31% per year on more than $1.3 trillion of client cash, and as rates rise, what it earns on its loan portfolio should increase at a faster clip than what it pays for deposits.
Plus, in contrast to many other U.S. banks, Wells Fargo still has "easy" levers to drive profit growth. The company only recently started to close branches to eliminate unnecessary expense, a move that should streamline its operations and save it about $500 million in pre-tax costs by 2021.
At 1.7 times tangible book value, Wells Fargo is priced as if it will forever live in regulatory purgatory, unable to grow because of a consent order that requires it to keep its balance sheet sized at about $2 trillion. But I believe it's only a matter of time until Wells is allowed to grow once again, and investors who buy at a depressed valuation because of regulatory uncertainty will net out a better-than-average return when the consent order is lifted.
Wow on Wall Street
Dan Caplinger (Goldman Sachs): Goldman Sachs has already seen a nice boost to its business recently, as a combination of more turbulent financial markets and rising interest rates have helped the Wall Street banking giant take greater advantage of its prowess across many facets of the finance industry. As my colleague Matthew Frankel noted recently, Goldman has also been ramping up its consumer banking platform, aiming to get more deeply into that part of the banking sector at what could be the most favorable time for the industry as a whole.
What stands out for me, though, is the company's ability to outperform its peers on the investment front. In the first quarter, Goldman managed to produce growth of more than 20% year over year in sales from fixed income, currency, and commodity trading. That compared to flat to negative performance for its biggest rivals in the trading space. Moreover, Goldman's efforts in the equities trading and investment banking areas were equally outstanding, showing the company's continued reputation as an industry leader.
Even with fundamental prospects improving, Goldman shares have given up ground since their highs earlier this year. That seems like a big disconnect, and it opens up an opportunity for those who believe in the long-term success that Goldman Sachs is likely to produce over time.
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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 owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.