By
Tom Hutchinson
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December 13, 2007
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It's a shame that the good children have to suffer just because of a few bad apples. That's what my elementary school teachers used to say when keeping the whole class after school. The same thing applies to today's bank stocks.
Many lenders went off a cliff by greedily gorging themselves on subprime loan spreads, and now the markets are punishing the responsible banks as well. Perhaps most conspicuous in this unjustly victimized group is US Bancorp (NYSE: USB ) . The stock trades at a modest 13 times earnings, with a nearly 5% yield.
US Bancorp is one of the largest and most profitable banks in the country. While the average return on equity for the banking industry as a whole is 10% and falling, USB boasts an astounding return on equity of more than 20% and rising. In addition, USB has significantly reduced its mortgage exposure and the credit quality of its loans has actually improved over the past quarter, while that of many banks has deteriorated. Just Tuesday, US Bancorp increased its dividend from $1.60 to $1.70.
Most importantly, Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) Warren Buffett likes the stock and has recently taken a large position. Do you need more of an endorsement than that? Perhaps he is enamored with the predictable cash flow; USB derives more than 50% of its income from fees. Most likely, however, he likes the stock because of the single piece of financial data that is most often associated with Buffett: return on equity. As he says, "If you have a business that's earning 20%-25% on equity, time is your friend."
What does all this mean? We are in an environment where three-year CDs are paying around 4% on average. Where can one earn a decent return in this uncertain market without having their head handed to them? With USB, you can earn 5% with a fundamentally solid bank while you wait for the market to realize it's been oversold. True, there may be more dark days ahead for the market and banks stocks in particular. But isn't that value investing? You buy when the market fears more bad news ahead. You may have to wait for USB to rise, but you're being paid to wait -- to the tune of 5%.
In baseball, there's a time to bunt and a time to swing for the fences. Today's volatile and uncertain market says bunt. And what better way to do so than with a solid company that pays you more than CDs or Treasuries while you wait to realize a profit on the stock price? USB is an easy choice. But, as Warren Buffett says, "there seems to be some perverse human characteristic that likes to make easy things look difficult."
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