I'm buying more of some of my favorites in the financials-centric real-money portfolio I manage for The Motley Fool: best-in-class megabank Wells Fargo (WFC -1.11%), ongoing insurance comeback story AIG (AIG -0.45%), and Midwestern regional banker Fifth Third Bancorp (FITB -1.10%).
Why am I doing three rebuys instead of purchasing the shares of a new company?
The big picture
As background, I track around 500 publicly traded financial companies, looking for solid performers trading at a discount. Depending on market sentiment, there are sometimes many candidates that look tantalizing after my initial screen -- and sometimes very few.
These days, after some decent rebounding in financial stocks, and with the U.S. market's 10-year P/E at 23.7 as calculated by Yale professor Robert Shiller, it's closer to "very few."
Internationally, I require a greater margin of safety, because I know less about the ins and outs of banking outside the United States. So when European majors such as Banco Santander and Deutsche Bank trade at similar multiples to book as American too-big-to-fail banks, they're not yet cheap enough for me dive in further.
Wells Fargo
Right now, because housing and the economy have been perking up, many banks' loan portfolios are looking deceptively good. We've seen bad loan and charge-off percentages steadily lowering over the past few years. That doesn't tell us too much about the loans the banks are making today. Only time and the next crisis will separate the truly recovered from the temporarily beautiful.
Let's start with Wells Fargo. Wells almost always trades at a premium to other large U.S. banks. My ongoing buy rationale has been that (1) the premium to lesser banks is justified, and (2) on a historical basis, its price multiples are well under where they've been.
As an aside, because of its crisis-time purchase of Wachovia, Wells looks worse than a lot of banks on loan quality, with 2.2% of its loans not performing. (For comparison, Fifth Third's rate is exactly half that amount.) It's also provisioning for only 90% of those bad loans. (For comparison again, Fifth Third is more than double that figure, and I like usually like banks to provision 100% or more.)
This is where trusting management comes in. Banks can play lots of accounting games when they classify what gets counted as a "bad loan." Based on Wells' conservative history, and because the bad loans were due to the purchase of a bank whose portfolio it knew to be toxic, I'm willing to trust Wells' management on its decent-but-not-great bad-loan numbers. I believe that when the next crisis hits, this view will be borne out.
More importantly, the Wachovia purchase is an example of Wells Fargo's ability to seize an opportunity. Wells snatched Wachovia from the arms of Citigroup by being able to do the deal without additional help from the government.
Wells' recent domination of the mortgage market is another example.
The resultant profitability is why Wells can trade at a premium to its peers on a book-value basis (1.9 times tangible book value) but remain at just 11 times earnings.
AIG
Big-time insurer AIG was a poster child for what went wrong during the financial crisis, so there's no premium here. It's currently trading at just 0.7 times tangible book. If you look at the average of 10 of its peers, they weigh in at 1.5 times tangible book. In other words, because of its past, AIG is trading for half of what a comparable property casualty insurer currently does.
I believe that's too low, because its problems have been fixable.
First, its AIG Financial Products unit -- the one that gambled with Wall Street, lost, and precipitated AIG's government bailout -- was closed in 2011, and the wind-down process (read: getting rid of the bad stuff) is more than 90% complete.
Second, back in December, the government fully exited its stock position in AIG (the government's stake had peaked at 92.1%.) AIG will still have to deal with regulators -- not necessarily a bad thing, given its past -- but with the government effectively out of the ownership picture, AIG is again its own boss, and a market headwind is removed.
Fifth Third Bancorp
Fifth Third is a Cincinnati-based regional bank that I first bought shares of for the portfolio in August 2011 -- when shares of it and many banks fell during that debt-ceiling "crisis." Today, its stock price is almost 90% higher, but its fundamentals are still doing well.
I'm seeing a bank that strikes a balance between interest income and non-interest income. It's maintaining a good spread between its net interest margin and its cost of borrowing, and it's displaying good efficiency in its operations. All that is currently generating an impressive 1.5% return on assets.
On a relative basis, its price-to-tangible book multiple is in the middle of the road at 1.4, but it's able to turn its balance sheet into enough profits to trade at just 9.5 times earnings and pay out a 2.7% dividend yield. Not too shabby.
After waiting a full trading day (per Fool guidelines), I'll be buying Wells Fargo, AIG, and Fifth Third in my real-money portfolio. Click here to see the rest of my portfolio or follow along.
