Rising interest rates and modest growth in loans and deposits should drive further momentum in U.S. bank stocks, which have been grossly outperforming the broader market over the past two years. Particularly, the prospects for major regional banks look bright in the near term as their scale will help them benefit more from a steadily improving domestic economy and the impending easing of regulations.
Moreover, continued efforts to restructure operations and improving asset quality and capital position should keep aiding profitability growth.
However, the rising rate environment, which should continue driving interest income growth, will keep corporates away from debt and equity issuance and consequently result in dismal investment banking performance. Also, higher rates will make mortgage loans less affordable for borrowers, which will put some pressure on mortgage banking revenues. Nevertheless, uncertainty-induced volatility might continue for some time, which will keep supporting trading business.
Further, digitization of banking operations will result in more cross-selling opportunities. This, along with focus on core operations, should lead to improvement in operating efficiency and lend support to banks’ efforts to manage expenses. Also, easing of regulations and lower tax rates should aid bottom-line growth.
Attractive Shareholder Returns
Looking at shareholder returns over the past two years, it appears that the border economic recovery was in favor of the industry. Gradual improvement in operating environment and policy changes were the other factors encouraging investors to bet on major regional bank stocks.
The Zacks Major Regional Banks Industry, which is a 16-stock group within the broader Zacks Finance Sector, has outperformed both the S&P 500 and its own sector over the past two years.
While the stocks in this industry have collectively gained 55.3%, the Zacks S&P 500 Composite and Zacks Finance Sector have rallied 33.8% and 29.8%, respectively.
Two-Year Price Performance
Major Regional Bank Stocks Trading at Slight Discount
Despite the outperformance of the industry in the past two years, the valuation doesn’t look too expensive. 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 banks 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 2.40, which is slightly above the median level of 2.17, over the past two years. When compared with the highest level of 2.68 in that period, there is apparently some upside left.
However, the space looks pretty cheap when compared with the market at large, as the trailing 12-month P/TBV ratio for the S&P 500 is 10.12 and the median level is 9.18.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a lower P/TBV ratio, comparing major regional banks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with that of its border sector ensures that the group is trading at a decent discount. The Zacks Finance Sector’s trailing 12-month P/TBV ratio of 2.96 and the median level of 3.49 for the same period are above the Zacks Major Regional Banks Industry’s respective ratios.
Price-to-Tangible Book Ratio (TTM)
Outperformance May Continue Given the Improving Earnings Outlook
Expectations of improving profitability with rising interest rates, a decent demand for loans and other strategic initiatives should help major regional bank stocks continue generating positive shareholder returns in the near future.
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 is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences the near-term performance of its stock.
One can get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with last year’s reported number, but an effective measure could be the magnitude and direction of the recent change in earnings estimates.
The consensus earnings estimate for the Zacks Major Regional Banks industry of $4.55 per share implies a decent year-over-year improvement. Also, the trend in earnings estimate revisions has been favorable.
Price and Consensus: Zacks Foreign Banks industry
Looking at the aggregate earnings estimate revisions, it appears that analysts are becoming more confident in this group’s earnings potential. The consensus EPS estimates for the current year have been revised 1.1% upward since Mar 31, 2018.
Current Year EPS Estimate Revisions
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 Major Regional Banks industry currently carries a Zacks Industry Rank #41, which places it at the top 16% 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.
Major Regional Banks Long-Term Growth Not Too Impressive
While the near-term prospects look bright, long-term (3-5 years) EPS growth estimates for the Zacks Major Regional Banks industry doesn’t seem much impressive. The group’s mean estimate of long-term EPS growth rate has increased modestly since beginning of 2018 and has remained stable for quite some time at current level of 8.45%. This compares to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
Since the beginning of 2016, revenues have been improving, mainly driven by rising interest rates and economic improvement. The effect of higher interest rates on the bottom-line numbers is expected to gradually reduce.
The effect of rising rates is expected to lessen in the long run and the operating backdrop may turn into a bit challenging one with easing of regulatory supervision. Also, the support banks receive from manageable expense levels at present might not continue as investments in technology and efforts to find new avenues will gradually increase expenses.
However, major regional banks will likely continue benefiting from higher interest rates, favorable operating environment and improving economy in the near term. So, betting on this space could be rewarding.
One should particularly consider betting on the major regional bank stocks that depict an improving earnings outlook.
3 Regional Bank Stocks to Bet On
Fifth Third Bancorp (FITB): The stock of this Cincinnati, OH-based bank has gained 20% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 6.4% 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: FITB
Comerica Inc. (CMA): The consensus EPS estimate for this Dallas, TX-based bank has moved 1.2% higher for the current year, over the last 60 days. This Zacks Rank #2 (Buy) stock has rallied 29.2% over the past year.
Price and Consensus: CMA
The Bank of New York Mellon Corp. (BK): The stock of New York, NY-based bank has risen 14.8% over the past year. The consensus EPS estimate for the current year has been revised 1.9% upward over the last 60 days.
Price and Consensus: BK
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