Avoid This Classic Value Trap

"Be fearful when others are greedy, and greedy when others are fearful." 
-- Warren Buffett

Nine times out of 10, I agree with Buffett.

However, given the magnitude and complexity of the eurozone crisis, I think the current fear in Europe's banking sector is quite warranted -- and I'd stay as far away as possible from the stocks listed below. Let me tell you how to avoid the classic value trap of these six stocks, and then give you one great financial sector stock that's actually worth buying today.

The typical trap you want to avoid
As value investors, often we look at crises as opportunities. We see stocks falling, P/E ratios lowering, and there is a natural inclination to look closer in order to find stocks at bargain basement prices. The eurozone crisis has presented such an opportunity.

For instance, if you're an average investor running screens for stocks that have taken a beating recently, that are trading at historical lows, and that have low valuations, you would probably end up finding some of the stocks below:

 

5-Day Price Change %

P/E Ratio

P/B Ratio

Bank of Ireland (NYSE: IRE  )

(11.7%)

N/A

0.06

Barclays (NYSE: BCS  )

(7.5%)

8.14

0.39

National Bank of Greece (NYSE: NBG  )

(5.9%)

N/A

0.19

BBVA (NYSE: BBVA  )

(4.7%)

6.69

0.75

Banco Santander (NYSE: STD  )

(3.3%)

6.79

0.67

HSBC (NYSE: HBC  )

(2.7%)

7.81

0.84

Source: Google Finance. N/A = not applicable due to negative earnings.

Each of the six banks above have fallen more than the Dow Jones (INDEX: ^DJI  ) over the past five days, and each are trading at seemingly ridiculously low prices. And some of them, most notably Banco Santander, have had a history of real success. In fact, I've pitched this as a great stock to own in the past for numerous reasons, including a strong balance sheet, great management, and a solid core tier 1 ratio.

Oh, how things have changed in the last few months, let alone the last year.

The problems are aplenty
Late last Friday, ratings agency Fitch warned that six of the eurozone economies could be hit with a credit downgrade in the near future, including the already embattled Spain and Italy. Fitch also surprised investors by saying it could cut AAA-rated France within two years. And then going for the jugular, Fitch concluded by saying that "a comprehensive solution to the Eurozone crisis is technically and politically beyond reach."

This matters because so far the European Central Bank, or ECB, has signaled that it is not willing to be the lender of last resort, providing a potential liquidity problem at the worst possible time. And if the countries mentioned above get credit downgrades, a vicious cycle could ensue where bond prices soar and debt becomes even more unmanageable to refinance.

Then there are the fiscal and financial problems of the eurozone. Sure, the EU Summit provided some detail for tighter fiscal restraints and accountability. How much of it will actually differ from the already useless Stability and Growth Pact is yet to be seen. But fiscal responsibility is only one aspect of the problem. Sanctions and discipline can only take these countries so far. Global competitiveness and growth is a necessity, and none of the countries in the eurozone seem to be able to balance the dynamic between moderate growth and tightening their purse strings.

And although the ECB has stated that it will accept higher-risk, assets-backed bonds as security for cash, in addition to lowering its reserve requirements for banks under pressure, it's not likely that these maneuvers will avert a credit crunch. Banks might get more money, but they are likely to sell assets, not make loans, which is what is really needed. Right now investors want to know European exposure on banks' balance sheets, so the chance that these banks take on more loans is dismal.

Of course, there are the political concerns involved in this calamity as well, which includes but is not limited to the possible extinction of the euro (it could happen!), the continued isolation of the U.K., and the inability of eurozone leaders to pass needed regulations that may be prevented by domestic political squabbling.

So where does this leave you?
Hopefully this leaves you far from wanting to invest in any European bank stocks. In fact, I'd normally be inclined to tell you to stay away from the global financial sector as a whole.

However, there's actually one bank that you could invest in today that could be a great way to continue having financial exposure, to invest in a small-cap stock, and receive an impressive dividend above 4%. Not only does this small bank generate gobs of profit (much more on a relative basis than the big-boy Wall Street banks), but it dominates its geographic industry and is a conservative player at a time when clearly that is not the latest fashion (I'm looking at you, MF Global).

If you're interested in hearing more about this outstanding investment, feel free to read The Motley Fool's brand NEW, special free report, "The Stocks Only the Smartest Investors Are Buying". Click here to access it, absolutely free!

Jordan DiPietro owns shares of National Bank of Greece; clearly his head was not clear during that decision. 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 (9) | Recommend This Article (21)

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 December 19, 2011, at 3:44 PM, ronbeasley wrote:

    Another blogger, trying to sell subscriptions, who tries to convince you that he knows more than Warren Buffett, Prem Watsa, Wilbur Ross and other billionaires who are investing in well capitalized financial service companies.

    I've been investing for nearly forty years, and have never seen more attractive valuations in this sector.

  • Report this Comment On December 19, 2011, at 3:50 PM, TMFPhillyDot wrote:

    @ronbeasley,

    Lol. Not a blogger at all; just an investor who has gotten burned by a company listed above and is trying to offer some simple advice.

    If you've never seen such attractive valuations in this sector, which companies do you suggest purchasing and why?

    Best,

    Jordan (TMFPhillyDot)

  • Report this Comment On December 19, 2011, at 5:14 PM, Jerry20000 wrote:

    I own STD and its a good stock. Has paid me hansomly. Has been high beta so I have averaged in and out to get my value at almost no cost to me. The bogus boggy man is making it wise to be a day trader, but if stocks are not active then what's the point. If you are looking for slow and boring get in the currancey bizz. Jap/Dollar. Valuations based on bad money is a poor bet though. Valuation based on Gold is real and I can base finanical trades any time off of its volume. Bring back the gold standard and this experiment in computer digitized paper is dead.

  • Report this Comment On December 19, 2011, at 5:16 PM, Notfooled1 wrote:

    Jordan is a Fool which means that his suggestions are suspect. THE FOOL's sole interest is to sell subscriptions. Their track record is NOT GOOD. BEWARE of anything they tout.

  • Report this Comment On December 19, 2011, at 7:09 PM, TMFPhillyDot wrote:

    @Notfooled1,

    Of course I am a Fool; that is why I sign off with a clearly designated Motley Fool handle. And how could my suggestion be suspect when I clearly illustrate my positions in the disclosure? I actually own the stock I'm criticizing, so my only interest here is to provide people with what I think is sound advice.

    And in terms of The Motley Fool's track record -- check out our home page; every single newsletter clearly states our returns vs. S&P. How many other subscription businesses are that financially transparent? I actually challenge you to find a company that (a) has beaten the market so consistently over the years, and that (b) scores themselves honestly and openly to the public.

    Best,

    Jordan (TMFPhillyDot)

  • Report this Comment On December 19, 2011, at 8:50 PM, dbtheonly wrote:

    Jordan,

    Does the chart really show that for a dollar of "book value" you pay only 6 cents for IRE? (probably less it was down about 4% today)

  • Report this Comment On December 20, 2011, at 1:10 PM, Teacherman1 wrote:

    I own 4 of the 6 stocks you listed and am quite content to continue to do so.

    The only one I am currently "underwater" on is IRE, and that has more to do with the "multiplier" than the bank itself.

    If you buy them at the "right price", watch them closely, and don't over extend yourself, these are no more "scary" than most others stocks in this market.

    One of the 2 I don't own is NBG, and that is because I had my start limit price set so low, not even they could reach it.

    The other one I don't own is HSBC, and that is because it does not have the upside potential that the others do.

    My reasoning is that they are all oversold, and if they get even more oversold, I am willing to buy more to lower my longer term starting price even more.

    JMO and worth exactly what I am charging for it.

  • Report this Comment On December 20, 2011, at 6:12 PM, racchole wrote:

    Jordan (TMFPhillyDot), I continue to be amazed at the level of professionalism on display by Motley Fool authors. You guys handle the narrow-minded, self-centered comments so well. It blows my mind that there are people in this world who "waste" their time repeatedly coming to www.Fool.com only to criticize and talk down the authors. It blows my mind.

    I am in no position to offer stock advice, but psychology I understand very well: I recommend therapy to all who get the urge to post defamatory remarks to the authors of these articles. There is something going on deep down that you have not yet figured out.

    It is mind-boggling to know that there are individuals who are so intelligent that they can invest successfully for their entire lifetime, but are unable to look in the mirror and see the true face staring back at them.

  • Report this Comment On December 20, 2011, at 9:48 PM, TMFPhillyDot wrote:

    @racchole,

    Thanks so much for the compliment. All the authors at The Motley Fool strive to be as unbiased as possible, and so we really do attempt to offer sound advice, in addition to treating people well in the process. It's not always easy -- but it's worth it. =)

    Thanks again,

    Jordan (TMFPhillyDot)

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