It would seem that after the latest sell-off, financial services stocks would be a screaming "buy" for most investors.
It would seem that after the latest sell-off, financial services stocks would be a screaming "buy" for most investors.
After all, the average price-earnings ratio of such stocks stands at 11.9, down from 12.2 in April, and making it the lowest valuation of the 10 sectors that make up the Standard & Poor's 500 stock index, according to S&P of New York.
Through Oct. 19, the Russell 1000 Financial Services Index was down 8.7% year-to-date, making it the index's worst-performing sector, and the index lost 7.2% of its value for the week. Yet for many investors, the lower valuations aren't enough to compensate for what could be a multiyear slowdown of earnings.
"For me to get excited, I would need to see more of a pullback," said Cory Shipman, financial-institutions analyst with Stanford Group Co. of Houston.
He noted that many of the regional banks he follows trade at p/e's of 13.7, which is in line with the historical average for the group. This is, of course, much more attractive than the 16 times at which they were trading.
Problems at Calabasas, Calif.-based mortgage lender Countrywide Financial Corp. and other lenders took the sector downward this summer.
However, Mr. Shipman isn't convinced that banks are in a position to expand their earnings, given eroding economic conditions. He thinks that poor credit quality will continue to pull the stocks down.
"Earnings growth is going to be more difficult to achieve going forward," Mr. Shipman said. "Do these stocks deserve to trade at historically average multiples, given those pros-pects?"
Exacerbating matters is a concern that the number of loan defaults hasn't yet peaked. The lack of clarity on a potentially dangerous situation has many investors holding back.
"We're trying to figure out whether the [banks'] loan book is shrinking," said Sam Dedio, portfolio manager of the $11 million Julius Baer U.S. Smallcap fund, offered by Julius Baer Investment Management LLC of New York. "If it's still in shrinking mode, and the loans are coming off the books or are uncollectible, then the earnings won't be there."
Of the four Julius Baer funds that Mr. Dedio manages or co-manages, none have exposure to banks or investment banks.
Sam Stovall, chief investment strategist at S&P, cautions investors against dumping financial stocks wholesale right now.
"What we've been saying is, 'It's too late to underweight,'" he said. "We should have been more nimble on downgrading of financials, but let's not make a bad situation worse by selling now."
Mr. Stovall recommends holding on to and even adding to positions opportunistically.
S&P predicts a 7% earnings increase next year for financials. While that is higher than the 4% growth rate the group is ex-pected to log by the end of this year, it lags the remaining stocks in the S&P 500 by about half.
Still, the reduced valuations make the sector more attractive than ever before, Mr. Stovall said.
S&P has a "strong buy" rating on three diversified financial services firms: Bank of America Corp. and Wachovia Corp., both of Charlotte, N.C.; and Citigroup Inc. of New York.
However, real estate investment trusts and regional banks largely have negative ratings because of the former's direct link to the housing market and the latter's ties to problematic subprime mortgages.
Despite Mr. Stovall's outlook for the large companies, the past few weeks have proved that investors aren't ready to jump in quite yet.
At midmonth, Bank of America, Citigroup, JPMorgan Chase & Co. of New York and other banks formed a consortium to fund a pool aimed at reviving the commercial-paper market at the behest of Treasury Secretary Henry Paulson. Their stock prices fell sharply as a result.
"[The sell-off] is making a lot of companies — that for the long-term are wonderful companies — very cheap," said Jaime Peters, a financial services analyst with Morningstar Inc. of Chicago. "I'm not going to say this is the bottom, but this would be a very good time to enter the sector."
Ms. Peters argues that Citigroup and JPMorgan have what it takes to emerge from the turmoil.
"The credit markets aren't going to be down forever," she said.
But others think that there is more pain in store before financials are worth another look.
Walter McCor-mick, senior portfolio manager of the $1.2 billion Evergreen Equity Income Fund, has a sizable holding of Citibank but isn't adding to his position. The fund is offered by Evergreen Investment Management Co. LLC of Boston.
"Because of its troubles, Citi had to stop a share repurchase program, and it will not be in a position to increase the dividend," Mr. McCormick noted.
Yet he and others said that one cannot dismiss all financial companies with one brush stroke. Even in this difficult market, asset managers have much going for them as baby boomers continue to invest for retirement.
