Industry Focus Picks Our 4 Favorite Stocks Right Now

Everybody likes a good stock recommendation. In this episode of Industry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield talk about four stocks that they like right now. Listen in to hear about two industries that seem to offer opportunities for bargain hunters, as well as one popular stock that's seen its price cut in half over the past year.

A full transcript follows the video.

This podcast was recorded on Aug. 22, 2016.

Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You are listening to the Financials edition filmed today, on Monday, Aug. 22, 2016. My name is Gaby Lapera. I am your host for today's show and joining me on the phone is John Maxfield, one of The Motley Fool's top analysts. Thanks for joining us, John. How's it going?

John Maxfield: It's going great. Thank you very much for having me, Gaby!

Lapera: I'm really excited to have you. We thought that we'd go kind of simple, kind of old school for today's episode, and just chat about a few stocks that John and I are kind of interested in buying. They may or may not be on our watch list. Just stocks that we've kind of had on the brain for a while. I hope you guys are excited for it because I know I am, and in fact, I am so excited that I think I'm going to go first.

John, you and I were chatting earlier before the show about industries that are cheap right now, and one of those is banks. No one really wants to buy banks right now, which is fine, and there's a whole host of reasons for that. There's a lot of global instability in the financial markets. Think Brexit and China. Energy instability ends up affecting banks, so think Cullen/Frost Bankers and the price of oil going down in Texas, and that affecting the smaller local banks and just general volatility has made people a little bit more hesitant to invest in banks. That doesn't mean that banks aren't a good deal.

Now that I've prefaced that, I have to tell you that I am a risk-averse person. I don't think that you would guess that I'm 27 based on my behavior -- maybe more like 67. This first bank really appeals to that side of me, and it's Bank of Hawaii (BOH -0.55%).

Maxfield: Bank of Hawaii is a great one. It's interesting, Gaby, because everything that you say is extremely valid. If you're going to go out and buy a stock, why would you want to buy one when everything is going great for either that industry or for that particular company at that particular time? That's when the shares trade for really high valuations. Right now, stocks are really expensive. So, if you're going to go out and really look for good purchases as an investor, you've got to look in those corners of the market where there's something else that's going on that's depressing valuations.

Banks stocks are a perfect example, but here's the irony, Gaby: You've picked one of ... Over the past decade, it's one of the best-run banks.

Lapera: I know what you're going to say.

Maxfield: It's such a good bank, and it's one of those that you can't go wrong with that holding, so it's a great core bank stock to add to your portfolio, but you've certainly picked one that isn't cheap right now.

Lapera: Well, it's slightly cheaper than it has been.

Maxfield: Yeah, that's true. Here's what's interesting, when I think of Bank of Hawaii ... I don't know if you're the same way, Gaby, but when I think about companies, I always try to think about one tangible thing about that company that really sticks in my head and then I can pull that up and then work backwards from there when I'm thinking about a company. The one thing about Bank of Hawaii that I think of is the fact that it is such a good bank. This is a regional bank that's based in Hawaii.

Lapera: As the name implies.

Maxfield: Exactly, but it is such a good bank that when Citigroup -- which went into the crisis as the largest bank in the country -- got into trouble and had to change out the chairman of its board, do you know who they picked? They picked the former CEO of Bank of Hawaii.

Lapera: I actually didn't know that!

Maxfield: Investors in the bank industry, we know about Bank of Hawaii because it's an incredibly well-run bank, but this isn't just like a small regional bank that's just on that radar. The top banking people in the country know how well run that thing is.

Lapera: Just to give a little bit of context to that. Bank of Hawaii, as far as banks go, is actually not that big. It's only got a market cap of $3 billion. (I love that. I can say stuff like, "It's only got a market cap of $3 billion." It's kind of like geological age, like the numbers just stop fazing you at certain points.) Anyway, market cap of $3 billion, and it has a really impressive performance in terms of nonperforming loans. Over the years, its ratio has hovered around 0.2% of total loans, and that's only 0.1% of total assets, which is pretty incredible. And their coverage ratio is over 170%. Just to back up, a coverage ratio is basically how much the bank has saved up just in case loans go bad. Ratios above 100 mean that they can definitely cover any loans that go bad.

Maxfield: Here's the other thing. That credit risk element is such a critical element. Talking about bad loans and a 0.2% ... I don't know if that's their net charge-off ratio or if that's how much they're putting away in provisions. That is so critical because when you think about banks, you really want two things -- three things if you throw in valuation.

The first is that you want a bank that's profitable enough that it is more than earning its cost of capital. That means that it's been creating value for shareholders. The Bank of Hawaii has consistently done that over the years. The other thing -- and I think this is something investors have a tendency to overlook when you think about bank stocks -- is that it's not just about generating a high profitability in good times. What's equally as important -- in fact, one could argue it's more important -- it's about consistency of earnings over a long period of time. Because you don't want to give all of those earnings back every time the cycle turns around.

Lapera: Yeah, absolutely. I can't remember off the top of my head, but Bank of Hawaii's nonperforming loan ratio has been consistently low, even through the financial crisis. Part of that is the real estate market in Hawaii is so tight at all times, and the homes that are being built there are generally fairly expensive. The type of people who are buying houses in a Hawaii, generally, have better credit. It's just because of the market.

Bank of Hawaii is super-duper tied to the Hawaiian economy, and it's really just been on the rise for the last few years, including a lot of luxury construction, which they talked about in the transcripts. They think that some of the luxury high-rise construction is winding down, but they don't seem to think that there's going to be any less construction going forward in the future. With the strict underwriting standards that they have, clearly it seems like it's a good time to be with Bank of Hawaii.

Maxfield: Yeah, I would agree, and I would agree even more with the general proposition that the banking sector is a place to look. To play off of that, my first stock that I'm thinking about is in another sector that, like banking, is really lagging the market right now, and that's the energy sector. We have [oil] prices that were well over $100 a barrel a couple years ago, and in 2014, they started heading down very sharply. Now, they're around $50 a barrel right now. I think they'd gone down below $30 a barrel. That's really constraining profitability in the energy space, just like all these issues, these headwinds, that are causing banks profitability to fall. The thing is that you've got to keep in mind that everything works in cycles -- whether it's banking, whether it's energy. It is possible that oil prices could stay low for the rest of human existence, but that seems unlikely when you look at the history of oil prices and how volatile they are.

The one that I like in the energy industry, and I actually own this stock, is Exxon (XOM -0.05%). Of course, I know that [choosing] Exxon is like, "He picked the most boring one in all the energy industry," but the thing I like about Exxon is that it is really capably managed. As opposed to being just an oil and gas company, I think you can look at Exxon more as an energy platform. Even if things change in the industry, which they will, it will move away probably from fossil fuels. That's already going on, and it will move into other areas. But if a company like ExxonMobil can play it right, it can dominate that new space just as much as it's been dominating the current space. When you look at what happened to a stock price over the past few years and its profitability, it just seems to me like this is a great opportunity to get in on a great company in a sector that is ailing.

Lapera: Can I ask you a little bit about what Exxon actually does? Because I know that there's different players in the energy space. There's people who look for oil and there's people who actually construct the physical pipelines and there's all sort of different players in the field. What kind of work does Exxon do?

Maxfield: It's an integrated oil company, which means that it does pieces all along that production chain in terms of going out, finding gas, drilling it, and then delivering it to consumers. This is another great aspect of Exxon, because you have that natural hedge from the fact that it is in so many of these different areas. Let's say, for example, selling gasoline to consumers. Well, low oil prices are really bad on the production side, but not as bad on the consumer side, because consumers are going to be, presumably, buying more gas when prices are low. I'm glad you brought that up. That's another point about Exxon that is a real selling point for investors.

Lapera: It's what we call vertical integration. I have another bank to pitch, and this one is in the complete other direction from Bank of Hawaii. As I was talking to my mother last weekend, she always wants know if I'm going out, and if she happens to call me at like 9 p.m. on a Friday she's like, "Why are you still at home? Are you going to go out?" In honor of my mother, who wants me to live my life to the fullest, and to try and reel back my risk-averse nature, I have picked Silicon Valley Bank (SIVB.Q) or SVB -- as I'm going to call it through this segment.

Silicon Valley Bank is slightly larger than Bank of Hawaii, with a market cap of around $5.4 billion, but it has a totally different business model. Where Bank of Hawaii is really focused on real estate, Silicon Valley Bank is really focused on commercial loans. It really focuses on lending, in particular, to venture capitalists and start-ups, and as its name implies, it's in Silicon Valley, where there are a lot of those.

Maxfield: The way I think about Silicon Valley Bank -- I agree it is a great bank, really interesting bank, niche bank with its focus on the technology sector. But what I think about when I think about it, it's like an old-school merchant bank that provides services to technology companies. What's interesting about it is that even though, to your point, it has a different risk profile than Bank of Hawaii because it's dealing with that technology sector, it's almost more on that cycle, as opposed to your traditional banking cycle.

Lapera: Yeah.

Maxfield: What's great about it is that if you look at its balance sheet, it's actually a pretty safe bet from a credit perspective. Because between banks, they take money from depositors, they go out and they either make loans -- which is the way you can make the most money, because interest rates on loans are the highest interest rate a bank can get on the type of assets that it has. You can either do that, or you can go and buy safe securities: government bonds and things like that. Government bonds are safe, so they earn a lot less money. What Silicon Valley Bank does is -- because it makes a good amount of money, particularly for its size, from non-interest sources, by serving as a quasi-merchant bank to the technology sector. It's able to take less risk in its asset portfolio. They actually hold more securities on their balance sheet than they do loans, which is unusual for a bank, but it's great, because it really reduces that risk profile.

Lapera: It's insane. It's something like 80% of their assets are held in securities, or something like that.

Maxfield: Yeah, it's a large chunk.

Lapera: It's really interesting that you talk about "old school," because one of the things that Silicon Valley Bank is most known for is its relationships with its customers. People don't hesitate to take out a loan with Silicon Valley, and venture capitalists don't hesitate to do business with them, because they have a softer touch. Sometimes start-ups, they can be what seems like on the ropes, and [then] rally. Silicon Valley Bank works with these people to make sure that they have the best opportunities to do that, which is not something that all banks are really interested in doing. I think a lot of people have this idea of banks that it's like, when you stop paying your loans, they're immediately on your case and calling you and trying to foreclose on you and all the these things. Silicon Valley Bank is basically the opposite of that for start-ups, which is really important for fledgling businesses like that.

Maxfield: I read the craziest statistic about Silicon Valley Bank the other day, a couple weeks ago. One of the things that it does is, it banks some of the top tech entrepreneurs in the country and not only banks their companies, but also banks them on a personal level. I read the other day that they were able to get Mark Zuckerberg's accounts. I don't know if they got all the accounts -- I'm sure Mark Zuckerberg has accounts at many banks. They are one of his bankers and they underwrote his mortgage at something like 1.7%. I don't know exactly on that statistic, but I mean like well below the market rate for a mortgage.

Lapera: It's actually really interesting that you mentioned that, because I think their residential mortgages are invitation only. So, they will reach out to people and venture capitalist firms or start-ups and say like, "We would like to help fund your mortgage." Which implies that the mortgages are probably pretty safe if they're invitation only.

Maxfield: I don't know about you, Gaby, but I would definitely RSVP in the affirmative for that invitation.

Lapera: Definitely, and just to give you an idea of how Silicon Valley Bank is being run, its efficiency ratio in 2010 was 69.7%; by the end of 2015 it was 53.6%. That's crazy. Just for our listeners, lower is better when it comes to efficiency ratios.

Maxfield: The closer you can get to 50% is the goal. If you can get it under, that's amazing. The one thing to keep in mind about the efficiency ratio is that when it's calculated, it's a function of both your revenue and your expenses. My guess is that the fluctuation there, there may have been a revenue thing going on there, or they had some sort of weird one-time expense.

Lapera: If you look at the trend chart, it definitely starts off at 69.7% and then it definitely, slowly, steps down to 53.6%. Someone is doing something right over there, and [it's] not just that non-performing loans over total loans is 0.73%. I do want to caution people that that is up from 0.27% in 2014 and 0.52% in 2011, but that's still pretty gosh darn low.

Maxfield: That is low. We're in a good credit-rate environment right now, but it's always a good sign when those metrics are low.

Lapera: The other thing that's really interesting to me about Silicon Valley Bank is that they don't just hand out loans. When they're negotiating their packages, they also get warrants, which is the right to buy stocks in companies when they go public ...

Maxfield: That's right!

Lapera: ... which can be super valuable. Some of the other companies that Silicon Valley Bank has worked with are Twitter and Cisco, which are giants. I don't know if you saw this, but Wal-Mart bought Jet.com, and included in that purchase was $5 million in financing. That was housed completely at Silicon Valley Bank. So, good for Silicon Valley Bank!

Maxfield: Good for them.

I'll go on to my final one. This is not in an industry right now so much that is having problems like the oil industry, or one might say the bank industry is. However, the company itself has had some issues that has caused its shares to fall almost 50% over the past six months, and that company is Chipotle (CMG -1.34%).

Here's the thing about Chipotle. Its shares have literally been cut in half since it had a series of food-borne illness crises at the end of last year. The thing about it is that -- and I've written about this on Fool.com regularly over the past few months -- every other major food company, for the most part, in the United States has been through a similar experience, in terms of food-borne illness crises, seeing their stock fall, and then gone on to produce large gains. Whether that's Jack in the Box, McDonald's, Yum! Brands -- which owns KFC, Pizza Hut and Taco Bell.

Lapera: Can I ask you a question?

Maxfield: Of course.

Lapera: Have other brands had as a prolonged time period with food-borne illness news?

Maxfield: Really good point. There are some unique characteristics about Chipotle's food-borne illness situation. The first is that, like McDonald's -- its big E. coli scandal was I think in 1993, so that was pre-Internet so you didn't have that proliferation of information the same way that it happens now online. You didn't have that. However, while Chipotle seems like it's gone on for a long time, I think that what you really want to look at is the severity of the crisis itself. In that regard, Chipotle's was actually not very severe. Let me give you an example. Jack in the Box dealt with an E. coli situation, I can't remember exactly when that was. It was a couple of decades ago. Something like four people died from it.

Lapera: Wow. That's horrifying!

Maxfield: Yeah, exactly! Is Jack in the Box the busiest fast food chain ever? No, it's nothing like McDonald's or Chipotle or the other ones. But afterward, it went on to produce huge gains after that scandal. The point is that this is an opportunity to get in on a company that just last year was trading at almost twice the price and everybody was talking about what an amazing company it was. It goes through a pretty standard thing. It's not a good thing, of course, but it goes through a relatively standard thing for a company in its industry. Its stock falls 50%; it presumably will recover. This is the opportunity that you want to use to get in on a company like that.

Lapera: I have to say that there was a little bit there where that E. coli scare was great, because I eat at Chipotle all the time, and I would get in line and there would be no one there. I would get my burrito so fast, and apparently that fear is waning, because the lines are very long again, and that's upsetting to me as a consumer.

Maxfield: Let me ask you that. I'm out in Portland, Oregon, which is really where that E. coli scandal was centered. And not only that, but the Chipotle closest to my house is one of the restaurants that it happened at. I have noticed that at that restaurant, which we go to most frequently because it's close, the lines just have not picked back up to the pre-crisis level. Would you say that, from your perspective in the D.C. area, it has recovered, or that it's in the process of recovering? Where would you put that?

Lapera: This is completely anecdotal research based on me going to three area Chipotles. There is King Street Chipotle; Dukepotle, which we like to call the Chipotle on Duke Street; and the one near my house in Columbia Heights. All of those are slammed all the time.

Maxfield: Yeah, that's a great sign.

Lapera: Like I said, a few months ago, it was definitely a lot quieter. I guess this was in the winter. I don't know if it was just too cold for people to go outside. Like Snowpocalypse. The third version of Snowpocalypse, and people are still debating what to call that snow storm. Maybe that deterred them from going outside. Not me. I needed to get my burrito, but I don't know. I think it's doing fine. As far as I can tell, the food quality hasn't changed. I might just have a stomach of steel, or it could be that I'm so hyper-cautious that I ... I don't know if this is too much information, John. I'm going to share it with you anyway.

Maxfield: Share. Share away.

Lapera: I vomit a lot.

Maxfield: OK, that's too much!

Lapera: I am such a nervous vomiter, it's insane. It can be like emotional stress, it can be motion sickness, it can also be like I just psyched myself out of something, and that includes food. I haven't had that problem with Chipotle ever.

Maxfield: That's great. That's quite a recommendation. This doesn't have anything to do with that, but let me take this in a different direction. I think this is a great stock. It's my second-largest holding after Bank of America in my combined portfolio with my wife. Let me tell you the one part of the Chipotle thesis that a lot of people seem to be sold on that I am not sold on.

Lapera: Tell me.

Maxfield: That is this idea that these other concepts it is developing are really going to do well, and let me tell you why I question that.

Lapera: Are you talking about Chiptopia?

Maxfield: I'm talking about ShopHouse, their Asian concept.

Lapera: Oh, OK.

Maxfield: And Pizzeria, I think it's ... I can't remember. Pizzeria Locale or something like that. Their pizza concept that's in Denver. ShopHouse, their first restaurant was out there in D.C., and I think they have a couple of them now. You're just not seeing, at least from everything you hear from the company, the same acceleration in sales that you saw in Chipotle early on. That's one part of the thesis that I'm not as optimistic about as I think a lot of other people [are] that look at Chipotle and like its stock.

Lapera: On the other hand, I also think that since Chipotle does have such an established network, it's not as big of a risk as it could take. If another company were trying to do this earlier on in its life cycle, it would probably be a huge risk, but for Chipotle, it's kind of a middling risk, I feel like.

Maxfield: The other thing is that they are able to finance all of these things through its cash flow. It's not like going out and borrowing a whole bunch of money. In fact, if you look at its balance sheet, it doesn't have any debt. It's not like it's going out and borrowing and doing these things. It's not increasing the frailty of its balance sheet to do that, but still, it just doesn't seem to help out with that in terms of the premium valuation on its stock.

Let me just bring up one more point about Chipotle, and just to kind of put all this into perspective: One of the things that Warren Buffet talks about a lot is the importance of ... Because nobody can foresee the future, what's going to happen in any company. What you want to do to protect you on the downside is, you want to identify stocks where there's a margin of safety. Even if things do go bad, the downside is relatively limited. And when you think about Chipotle, it just looks like one of those asymmetric bets where the probability of it going up at this point seems to be much greater than the probability of it going down, because it's already dropped 50%. There's just a limit to how far it can go unless Chipotle is going to go away, which, again, the historical precedent does not support that. It's one of those stocks where I think you can get in -- this is my thesis on it, anyway -- assuming it's a long-term hold, and feel comfortable that you have a margin of safety built into that holding.

Lapera: I think that this was an interesting show that revealed a lot of my personal character flaws, and I'm sorry that you all had to hear it.

Maxfield: One very major one.

Lapera: I don't know if that's a personality flaw so much as a body flaw. I don't really know, but just make sure you don't sit behind me on a roller coaster.

Maxfield: Or in front of you.

Lapera: In any direction, don't get on a roller coaster with me is really the moral of the story to this podcast.

As usual, people on the program may have interest in stocks they talk about and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear.

Contact us at [email protected] or by tweeting us @mfindustryfocus. Thank you to Austin Morgan, today's totally awesome producer. Thanks for listening to my stories about puking, Austin. You rock! And thank you to you all for joining us, especially you, John. Everyone have a great week!