Is This Stock a Bank Bargain?

I'll bet dollars to doughnuts you've never heard of Lakonishok, Schliefer, and Vishny, unless you're a total investing dweeb like me. But before they founded LSV Asset Management, which now has $51 billion under management, they were obscure academics about to publish a very famous paper. Best of all, the insights they discovered can help you find stocks that will stack the odds of a successful investment in your favor. Read on to see whether what they discovered can make you money in bank stocks.

Turning investing upside-down
In 1994, the trio divided stocks into 10 buckets, according to earnings yield -- E/P, or the inverse of the price-to-earnings ratio, because academics prefer the exotic. LSV found that high-E/P stocks (also known as low P/E stocks, or value stocks) beat low-E/P, high P/E glamour stocks by 4 percentage points per year.

LSV next divided stocks into groups, using a formula based on sales growth. Amazingly, they found that boring businesses with low sales growth outperformed flashy high-growth companies by 7.3 percentage points per year.

Best of all, LSV found that a portfolio combining the high-E/P and low-sales-growth approaches outperformed its opposite – high-P/E, high-growth stocks – by 11 percentage points per year!

I keep LSV's formula in mind every month when I'm selecting dividend stocks for my Income Investor newsletter. Let's use it right now to dig up a slow, cheap, and potentially outperforming value stock for your own consideration. I used data from Capital IQ (a unit of Standard & Poor's) to unearth companies trading at a P/E less than eight, with sales growth of less than 4% last year.

Separating the fakers from the moneymakers
This approach gets us on the LSV track, but it's not a slam dunk. We can take price -- the "P" in P/E -- at face value, but not earnings -- the "E." One-off accounting items and business cyclicality can temporarily skew that metric. And while LSV's results did include essentially all low-P/E stocks -- accounting issues and all -- we presumably want the true low-P/E laggards, not statistical one-offs, to best capitalize on their findings.

Let's grab a stock at random from the Capital IQ screen and see what we can learn.

Banco Bilbao (NYSE: BBVA  )
You will not be surprised to learn that Banco Bilbao is, well, a Spanish bank. It also sports a strong presence in Latin America, and it's a former recommendation of my newsletter. Its sales shrank by 3.2% this past year. But is Banco Bilbao a statistical one-off? A peek at its past P/E and fellow industry participants will tell us.

Industry participants can range from clone competitors to nearly unrelated businesses, but their valuations provide initial perspective.

Company

P/E

Banco Santander (NYSE: STD  ) 8.4
Royal Bank of Canada (NYSE: RY  ) 15.5
UBS (NYSE: UBS  ) 8.6
JPMorgan 12.5

Next, are we dealing with a temporarily low P/E? A peek at Banco Bilbao's past reveals:

Year

2007

2008

2009

Latest

P/E

12.2

7.5

7.4

7.8

Actually, nothing too crazy is afoot here, meaning Banco Bilbao is just cheap, versus being a statistical one-off. That's not surprising, given the Spanish real estate crisis and the lingering tepidity with which investors view the banking sector.

Generally, if you scan the news articles on value stocks, you'll see plenty of reasons not to invest. But according to LSV's findings, those same reasons have already driven many investors away from stocks like Banco Bilbao. Thus, a company facing headwinds can get priced so cheaply that it actually becomes a good investment. Things don't have to go exactly right; they just have to turn out better than the market expects. In short, companies with low expectations can give you the best chance to score a truly great investment.

Add Banco Bilbao to your watchlist, or do the same for Banco Santander, Royal Bank of Canada, UBS, or JP Morgan.

A decade from now, you might thank us for these 3 perfect dividend stocks for a 2020 retirement.

James Early owns no stocks mentioned in this article. You can investigate his Motley Fool Income Investor newsletter free for 30 days.


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