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Is Banco Santander an Underdog -- or Just a Dog?

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Short-sellers and hedge funds may be shadowy, but sometimes they are the smartest guys in the room. They've done their homework, and they're willing to bet their capital against the crowd -- an investing strategy that can be as lucrative as it is contrarian.

On Motley Fool CAPS, we've also got leading analysts who find the chinks in a company's armor and correctly call its fall. Our "Underdogs" have earned 100 or more CAPS points by correctly predicting that one or more stocks would underperform the market.

Today I'm looking at Spanish banking giant Banco Santander (NYSE: SAN  ) , which has recovered almost 50% of the ground it lost after falling from its highs. Benefiting from Europe's commitment to defend the euro just as it announced its second-quarter earnings, not only did its stock soar, but it also rose sharply in the estimation of CAPS members, who boosted its rating from two to four stars. So if investors who've scored big by correctly predicting which stocks will fail, it may be worth our while to check out those they think will succeed.

Banco Santander snapshot

Market Cap $1.3 billion
Revenues, TTM $3.4 billion
1-Year Stock Return (4%)
Return on Investment NA
Estimated 5-Year EPS Growth 17.5%
Dividend and Yield $0.81/11.4%
Recent Price $7.13
CAPS Rating (out of 5) ****

Of course, not every short sale goes as planned, which makes shorting a risky proposition. Stock prices can be irrational longer than you have money to stay in the game. And you don't want to end up with fleas by lying down with dogs, so do your homework.

Don't bank on it
Europe may officially be back in recession, though anyone watching events over there would have figured that out a while ago. But manufacturing and services contracted sharply last month, while retail sales stumbled after a period of modest growth. Even Germany, which has heretofore been propping up the rest of the continent's economy, is sliding further into the abyss, hitting lows not seen in three years.

That's not a good omen for Banco Santander or Spanish banking peers such as Banco Bilbao (Nasdaq: BBVA  ) , which are counting on Europe's recovery to pull them up. Spain's economy is still in freefall along with fellow ne'er-do-well Italy.

A silver lining
If there's any ray of sunshine, it's that the Iberian 25% unemployment rate may finally have bottomed, as new claims tumbled less than they have previously. Additionally, Spain's economic minister predicts the country won't need the full $126 billion Europe set aside to bail out the industry. Naturally, that excludes Bankia, the financial institution the government took over and into which it will be injecting another $6 billion right away. Critics of the process, however, contend that by not taking the full bailout, Spain is merely trying to avoid as long as possible the loss sharing by bondholders required under the financing.

The economic woes have weighed heavily on Spanish banks as requirements to address the huge loan losses that reside in their balance sheets threaten their solvency. Santander saw its earnings plummet 93% as the cost of ridding itself of bad loans surged, while Banco Bilbao's profits tumbled 58% after it set aside $1.3 billion to cover losses.

Celebrate diversity
Yet half of Santander's revenues come from Latin America, as do its profits, where Brazil accounts for a quarter of the total. While that has allowed Santander to sidestep much of the crisis that has plagued the rest of Europe's money centers, as Brazil's economy flags it could pressure margins. It has also prompted speculation it may be willing to sell off assets to raise needed cash. Some suggest Brazil's Itau Unibanco (Nasdaq: ITUB  ) may wish to buy its U.S. unit or the domestic division of Societe Generale, or Royal Bank of Scotland (NYSE: RBS  ) , though Itau has denied the latter.

Itau's rival Banco Bradesco (NYSE: BBD  ) believes organic growth is the path to winning market share, and both it and Santander are seeking to capitalize on the delays engendered by Itau's acquisition of Unibanco. Bradesco is almost of equal size now, with Itau while Santander enjoyed a 6% increase in deposits in Brazil last quarter.

Unfortunately, I don't see Spain's woes relenting anytime, and though I believe Brazil's economic landing will be softer than feared, the precarious financial condition of Santander makes its current share gains seem tenuous. No doubt should the euro survive another year, the balance sheets will look much healthier in comparison, but expecting the eurozone to remain as is seems doubtful.

I've already marked Banco Santander to underperform the broad market indexes, but let me know in the comments section below if you agree it is a dog riddled with fleas or whether you think its diversification will allow it to emerge stronger.

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Fool contributor Rich Duprey holds no position in any company mentioned. Check out his holdings and a short bio. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (5)

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 September 05, 2012, at 9:38 PM, ajono wrote:

    isn't the current market cap of Banco Santander north of 68 billion? where did 1.3 billion come from?

  • Report this Comment On September 05, 2012, at 9:58 PM, ravens9111 wrote:

    the stock is pricing in a break up of the Euro. sorry, but i think the bears have it wrong. would i buy it at these levels? probably, but not all in yet. i would buy a slice and if it drops, buy a little more. it is a risky proposition, but that's what happens with great reward. if the ECB comes through tomorrow, i think all european banks will soar on the news. maybe the run has been too much too fast, but there is still plenty of upside if europe can get things right.

  • Report this Comment On September 06, 2012, at 4:11 AM, ramoncardena wrote:

    I also marked SAN in NYSE to underperform but in a 2-3 year period. On the other hand Im holding SAN stock in the Spanish Stock exchange, because I think in the long term (4-5 years) Santander will remain as the strongest bank in Spain (along with BBVA and CaixaBank)

  • Report this Comment On September 06, 2012, at 8:37 AM, ctstone wrote:

    This discussion is moot: if you're not a Banco Santander stockholder, you've already missed a golden opportunity. Clearly, SAN bottomed under $5 on July 24. The impressive 50% move in a little over a month underscores how oversold SAN had become. SAN continues to have far greater upside potential than downside risk, and the dividend alone will outperform market. Those of us who bought at the bottom now enjoy the substantial benefits of nearly a 20% dividend. Who cares whether SAN outperforms the market now? This is a glorious ride that's far from over.

  • Report this Comment On September 06, 2012, at 9:48 AM, DavesHere wrote:

    There is a basic principle of investing being overlooked in this and most contemporary risk analysis. That is, in assessing downside risk, analysts include the possibility of financial armageddon. The possibility of total collapse is very real, but if it comes, it will destroy all value, regardless of what particular investments are chosen, whether cash, gold, stocks, bonds, beef, corn, refrigerators, land or electricity. Investing, then, must include the assumption that the economy will survive, for the simple reason that, if it does not, it won't matter where we have put our money.

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