5 Scary Bets With Huge Upside

File these stocks under "high risk, high reward." That said, it's my belief that the best area to find market-beating returns right now is in banks.

And we can find many of these banks right here in the U.S. without having to speculate on the viability of troubled foreign governments like Greece, Portugal, and Spain.

Why is there opportunity in these banks? For a host of reasons:

  • Many investors are once bitten, twice shy on banks following the 2008 meltdown and bailout.
  • There's a good valuation spread between the "troubled" banks and the "healthy" banks.
  • The market's sentiment on individual banks can move from "troubled" to "healthy" pretty quickly, leading to nice returns.

I'll break down the opportunities into two areas: the too-big-to-fail group and the smaller, regional bank group. In all, I'll show you five scary bets with huge upside and weigh in on which ones offer enough upside to trump the fear factor.

Troubled too-big-to-fail banks

Company

Current Price

Current P/TBV

10-Year High P/TBV

Bank of America (NYSE: BAC  ) $13.51 1.06 4.85
Citigroup (NYSE: C  ) $4.53 1.02 5.24

Source: Capital IQ, a division of Standard & Poor's. P/TBV = price to tangible book value.

In the land of too-big-to-fail, Bank of America and Citigroup are generally regarded as the most likely to need another helpful hand from the government. You can see it in the higher valuations of the more market-respected banks. Wells Fargo's (NYSE: WFC  ) price-to-tangible book value is almost twice that of B of A (1.06 in the table above) and Citi (1.02). US Bancorp (NYSE: USB  ) is almost three times.

In general, the bigger the bank, the more inscrutable the balance sheet (i.e., the more derivatives, "financial innovations," and hidden risk). That said, Citigroup may be in its own class. If you tried to take Peter Lynch's advice and sketch Citi's business model with a crayon, you'd end up with a Rorschach test. Bank of America isn't far behind, if at all.

Financial regulation didn't fully defuse these ticking time bombs, so there is real risk of another 2008 scenario. Maybe that's why last month the Fed rejected B of A's plan to raise its penny-a-quarter dividend. And why Citi will only catch up to that meager dividend payout after its reverse stock split in May.

On the other hand, investors getting into post-crisis banks when skepticism is high can make a killing. See bank stocks in the 1990s after the S&L crisis. 

Is the bet worth it?: I believe shares of B of A and Citi are worth it now. There's real risk, but the chances of price-to-tangible book values doubling (to over 2.0) before the next big crisis are good. Especially if they're able to raise their dividends to more normal levels. But I'd seriously consider cashing in at least some of my profits if that double occurs.

Troubled smaller banks

Company

Current Price

Current P/TBV

10-Year High P/TBV

Synovus (NYSE: SNV  ) $2.73 1.06 5.71
Huntington Bancshares (Nasdaq: HBAN  ) $6.63 1.45 3.09
Regions Financial (NYSE: RF  ) $7.26 1.23 3.24

Source: Capital IQ, a division of Standard & Poor's. P/TBV = price to tangible book value.

The nice thing about the American banking system (at least for investors) is that there are hundreds of publicly traded banks operating under the same basic business model -- borrowing at one interest rate (e.g., deposits) and lending at a higher one (e.g., loans for homeowners and businesses).

As I noted earlier, things get exotic at the level of Bank of America and Citigroup, but they tend to get more vanilla the smaller the bank. Your community bank simply doesn't have the Wall Street clientele to support most of the Wall Street shenanigans.

There's still plenty of room for trouble, though, in making risky loans and using semi-exotic financial instruments.

Like B of A and Citi, the three banks above are all trading at price-to-tangible books between 1.0 and 1.5, well below their 10-year highs. On an absolute basis, I generally start to get interested at price-to-tangible book values below 1.5, so each is bargain-priced.

But now for the bad news. Synovus, Huntington, and Regions each took TARP bailout money from the government. Only Huntington has paid it back so far. It's also the only one that's eked out some profit over the past 12 months.

Drilling further into Huntington, its nonperforming loans have dropped from 5.2% of total loans in 2009 to 2% in 2010. That's a good sign. Also, I see that those non-performing loans are more than covered by allowances (i.e., Huntington's already taken the earnings hit on them).

Is the bet worth it?: In the community and regional bank space, I usually like to stick with the ones that weathered the financial storm better than any of these three did. I also usually prefer the comfort of dividends higher than 1.5%, 0.6%, and 0.6% for Synovus, Huntington, and Regions, respectively. That said, I'm warming up to the possible turnaround situation at Huntington. If its share price dips below $5 a share, I'll be very tempted to look more closely and pick up shares.  

The takeaway
Of the five scary banks above, I think Bank of America and Citigroup offer enough upside to justify a buy at today's prices. Of the smaller banks, Huntington is more intriguing to me than Synovus and Regions because it's more surely on the road to recovery.

For a detailed analysis on one more "high risk, high reward" stock opportunity, click here for our free report.

Anand Chokkavelu owns shares of Bank of America and Citigroup. The Fool owns shares of Bank of America and Wells Fargo. Through a separate Rising Star portfolio, The Fool is also short Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (22) | Recommend This Article (101)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 12, 2011, at 7:21 PM, baldheadeddork wrote:

    Or...you could buy a genuinely healthy bank that has been beaten down because the Citigroups and Fifth-Thirds have put a cloud over the entire sector. I have a decent amount of our Roth account in New York Community Bancorp (NYB), which has rock-solid financials and is paying a 5.8% dividend.

  • Report this Comment On April 12, 2011, at 9:32 PM, pastreet wrote:

    Living in the South, I can say that Regions certainly seems to have been struggling. The fact that they haven't paid back their TARP distributions makes it seem all that much riskier. What would Buffett do? I'd have to look closer at the balance sheet to know. But I like that you have taken a value perspective here. With the share prices this low, I can definitely see an upside.

    -Pat

    www.compoundingreturns.com

  • Report this Comment On April 13, 2011, at 5:11 AM, TulelakeFool wrote:

    Fools should be warned that there are several

    suits against BofA and its ownership of the junk

    CountryWide mortgages which were sold and resold in the financial markets as well as its own activities that contributed to the housing bubble. I anticipate that BofA will lose several thousands of properties as a consequence of these suits. I would not invest in BofA until I had thoroughly investigated the bank's involvement and its ownership of Countrywide concerning the charges which have been filed and are a matter of public record

    TulelakeFool.

  • Report this Comment On April 13, 2011, at 11:48 AM, mikecart1 wrote:

    BAC is the best thing that ever happened to me in 2009. Bought in the $3's and the rest is history. When it hits $30/share, I will be in Hawaii surfing some crazy waves. :o]

  • Report this Comment On April 13, 2011, at 4:35 PM, TMFBomb wrote:

    @TulelakeFool,

    See this article for my general thoughts:

    http://www.fool.com/investing/general/2010/11/01/its-time-to...

    @mikecart1,

    Congrats on the $3 buy-in!

    -Anand

  • Report this Comment On April 15, 2011, at 12:02 PM, Ibitit wrote:

    BofA took over the bank that held my IRA. They then gave me to Merrill Lynch. Is it even possible to judge how safe any of these questionable banks are? Should I be thinking of moving my IRA?

  • Report this Comment On April 15, 2011, at 12:07 PM, buffalonate wrote:

    Tier 1 credit ratings are improving across the board and forclosures have been going down now for months. This tells me it is safe to buy the sickly bank sector. If you wait for rosy news it will be too late.

  • Report this Comment On April 15, 2011, at 12:15 PM, 100tradejack wrote:

    yeah... C and HBAN look good, but now now.

    Jack

    www.100tradejack.com

  • Report this Comment On April 15, 2011, at 12:16 PM, 100tradejack wrote:

    I meant 'NOT' now.

    Jack

    www.100tradejack.com

  • Report this Comment On April 15, 2011, at 1:34 PM, DonDagenais wrote:

    When thinking banks, you need to realize that the housing mortgage market is still a swamp. But the caution signs have been removed around the edge, so people think it's over.

    Here is an ugly state for you:

    24.9% of mortgages in Miami/Dale are in default over 90 days, or in foreclosure. Banks are sitting on huge stockpiles of defaulted homes across the country but are not foreclosing due to the fact there is no market for the inventory. hy try to sell something you know you can't.

  • Report this Comment On April 15, 2011, at 2:27 PM, muddlinthrough wrote:

    If you wait for it to hit $30, prepare to wait a long time (probably never) to catch that wave.

    JDR's 'how'd you make your millions? By selling too soon' advice is the one that always haunts me.

  • Report this Comment On April 15, 2011, at 2:41 PM, COFool100 wrote:

    My Fool username tells it all! I wonder what the P/TBV number is for Fifth Third (FITB)? Where can I find there TBV? On the internet somewhere? Anybody else out there suffering a 6 digit loss? Do we have any hope?

  • Report this Comment On April 15, 2011, at 2:42 PM, COFool100 wrote:

    Well, it didn't take my revised Fool username for this submission! It was supposed to be foolish53fool!

  • Report this Comment On April 15, 2011, at 3:23 PM, MBRECRUITER wrote:

    One not-so-scary bet holding all 5 of the "scary bets" trading at 10.27% discount to NAV and paying a current 5.62% quarterly dividend with the same tremendous price appreciation upside and doubling of the dividend to pre-2008 levels and a management team a lot faster at ridding the portfolio of losers than any of us.

    BTO

  • Report this Comment On April 15, 2011, at 5:54 PM, TadpolesUS wrote:

    I prefer to think of the mega-banks as "too big to manage." While I have been happy with my WFC shares bought two years ago, I won't be buying any other large banks.

    Based on my experience as a Regions customer for 10+ years, they are not a good operator. Their two mergers (Union Planters and AmSouth) were botched, and their customer service is weak.

  • Report this Comment On April 15, 2011, at 7:14 PM, Loughney wrote:

    what do you think of IBKC? They seem to be improving results and growing.

  • Report this Comment On April 16, 2011, at 2:02 PM, TMFBomb wrote:

    @Loughney,

    I have IberiaBank (IBKC) on my watchlist for better prices (I'm pretty stingy about buy-in price). I haven't done a lot of diligence on them yet (would do that if the price fell), but I like what I've seen so far.

    My fellow Fool Todd Wenning gave a good rundown of them here:

    http://www.fool.com/investing/small-cap/2010/08/17/todays-bu...

    Fool on,

    Anand

  • Report this Comment On April 17, 2011, at 8:38 AM, orchestrafool wrote:

    Took a more conservative path, and bought into XLF (Bank ETF) a little over 2 years ago, and have done well, more than a double.

  • Report this Comment On April 17, 2011, at 12:32 PM, lovesstocks2 wrote:

    Several of these banks have never been accused of using good conservative accounting. One should never invest in a company not using the more conservative methods of accounting because the surprises just keep coming and coming.......

  • Report this Comment On April 22, 2011, at 7:42 PM, RockyTopBob wrote:

    Since publication BAC down almost 9% and the news is all bad. Anand, are you bottom fishing or just trying to push a stock you own?

    Bob

  • Report this Comment On April 26, 2011, at 9:35 AM, SkepticI wrote:

    Surferdude- if you had shorted BoA as I prefer to call them a few years back you would be in Hawaii now. I just completed moving all my assets from ML (acquired by BOA) to Vanguard. For good reason-ML almost failed. Same structure only worse because they are now 'managed' (I use the term loosely) by BOA. I've never seen a big bank more clueless nor more inefficient as BOA in its deal for ML. RUN! dont walk to the nearest exit. And no I dont own nor short BOA I stay as far away as I can. There are many other ways to profit from investment and many more good management teams and businesses deserving of your $

  • Report this Comment On April 26, 2011, at 11:18 AM, RockyTopBob wrote:

    And now BAC's CFO has left. What, no comment Anand?

    Bob

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