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3 Profitable Investment Signs You Can Bank On

http://www.fool.com/investing/general/2012/11/27/3-profitable-investment-signs-you-can-bank-on.aspx

Kevin Chen
November 27, 2012

"Be fearful when others are greedy and greedy when others are fearful." -- Warren Buffet

The financial sector is a scary place for Institutional investors. Banks are reorganizing business units, regulations are increasing, and the economy is weak. Luckily for you -- the individual investor -- the time is ripe. Banks still trade at all-time lows, but are much stronger than they were before the crisis. Before the financial sector becomes "hot" again, here are three signs you need to know to pick the best investment.

1. Price-to-book ratio less than 1
Financials were hit hard in the recession, and they have yet to bounce back completely. Since 2008, the Dow has lost 29%, while iShares Financial Index Fund has lost 38%! Though you might think institutional investors would jump at the chance to be greedy in a fearful market, that hasn't been the case. Many are still unsure how Dodd-Frank, the Volcker Rule proposal, and the fiscal cliff will affect banking's long-term profitability.

Yet one thing is for sure: On a price-to-book basis, banks look cheap.

Metric

US Bancorp (NYSE: USB  )

KeyCorp (NYSE: KEY  )

Huntington (Nasdaq: HBAN  )

FirstMerit (Nasdaq: FMER  )

Zions (Nasdaq: ZION  )

Price-to-book ratio

1.92

0.8

1.03

0.92

0.78

Source: Google Finance.

Though many investors swear by analyzing the company's price-to-earnings ratio, smart investors understand that the price-to-book ratio is better for banks.

All companies borrow and raise money (liabilities) to make more money (assets). However, banks are special -- they don't invest their money into a tractor, furnace, or semiconductor factory. Banks borrow a dollar to lend that dollar out at a slightly higher interest rate. That means a bank's assets and liabilities are both cold, hard cash. And cash is more easily valued than a factory. Since book value is the difference between total liabilities and total assets, the price-to-book ratio is a better signal of a banks' value.

Now, analyzing the above chart, we can see that four out of the five featured banks seem like great deals. At a P/B ratio of 1.03, investors are paying for just $1.03 for every dollar of Huntington Banc's book value. That's like paying a baker $1.03 for a pie that cost $1 to make.

Better yet, three of the banks seem like complete steals! With a P/B ratio below $1, investors are paying just $0.78 for a $1 piece of Zions' pie.

2. Debt-to-equity less than 10, preferably lower
Of course, just because banks are "cheaper" on a price-to-book basis doesn't necessarily mean they're good buys. After seeing what happened to banks like Lehman Brothers during the financial crisis, it's best to stay clear of debt (for banks and in general). At one point, Lehman Brothers had a debt-to-equity ratio of 60 -- for every dollar of equity the company had, it owed $60 to its l