Bank stocks have a lot going for them. Interest rates are rising, driving up loan yields. Unemployment is near a historical low, while economic growth is improving, resulting in low loan losses. Plus, last year's corporate tax cut has been a bigger boon to banks than to any other industry.
Some banks are better bets than others, though. Below, three Motley Fool contributors lay the case for Charles Schwab (NYSE:SCHW), Citigroup (NYSE:C), and JPMorgan Chase (NYSE:JPM) as bank stocks to buy now.
A bank in brokerage clothing
Jordan Wathen (Charles Schwab): It may not be the first company that comes to mind as a banking institution, but Charles Schwab is undeniably more of a bank than a brokerage or investment firm, given that more than half (roughly 55%) of net revenue is derived from net interest income.
What makes Charles Schwab special is its ability to attract deposits and pay almost nothing on them. Its annualized deposit costs were just 0.24% in the most recent quarter, even as short-term rates topped 1.7% for most of the period.
Being able to source funding at a trivial cost allows Schwab to earn high returns without betting the farm on risky loans. Margin loans to brokerage clients and bank loans to high-quality borrowers made up less than 15% of its average interest-earning assets in the most recent quarter. The bulk of its portfolio is made up of ultra-low-risk government and corporate securities. Even in the deepest of recessions, Schwab's credit losses should effectively round to zero. Schwab shareholders have little to worry about with respect to credit quality.
Rather, the question is whether Schwab can continue its robust deposit growth while paying a paltry rate on deposits. In my view, the answer is "yes." Customers flock to Schwab for features like fee-free ATM access all around the world, not just for the highest interest rate on their balances. Plus, Schwab has done extraordinarily well by enticing customers to move money-market fund balances to the bank, giving up a little bit in management fees for a much larger haul of net interest income. I see that continuing for some time to come.
A long runway for double-digit earnings growth driven by deposit growth, margin expansion, and rising rates makes Schwab a financial stock worth buying and holding for the long haul -- even if shares might not be optically cheap at roughly 20 times earnings expectations for 2018.
Big banks don't get much cheaper than this
Sean Williams (Citigroup): Choosing a bank stock isn't always easy, so I decided to enter a few ideal criteria into a stock screener to see if such a stock existed. I aimed to find a bank with a forward P/E under 15, trading for book value or less, with a PEG ratio of 1 or lower, and one that could deliver average annual earnings-per-share growth of 5% or greater over the next five years. Shockingly, one company met all these criteria: Citigroup.
While it's true that Citigroup has been the laggard of the big banks for quite some time, today's Citigroup is much different than that of, say, 2009. Namely, its metrics are almost universally moving in the right direction.
According to the company's most recent quarterly results, consumer banking loans were up in all major regions where Citi operates, with North America delivering the most robust increase to $192.4 billion, up $6 billion from the previous year. Meanwhile, net credit losses only modestly ticked higher to 2.28% from 2.2% in the prior-year period. While higher is traditionally not better, the bank simply attributed this increase to a greater number of loans outstanding.
Just as important, Citigroup has delivered seven consecutive quarters of an improved efficiency ratio. Think of a bank's efficiency ratio as its truest measure of margin, with a lower number suggesting that it's reducing expenses and/or expanding net income and margins. Over those past seven quarters, Citigroup's efficiency ratio has declined 200 basis points to 57.9%. By comparison, BankRegData.com's data shows that the average financial institution has an efficiency ratio closer to 60.6%.
Furthermore, while rising interest rates aren't going to be as big a boost to Citigroup as to its peers, it nonetheless disclosed in its first-quarter operating results filing with the Securities and Exchange Commission that it would be in line to generate $1.9 billion in added revenue should short- and long-term rates rise by 100 basis points. Since the Fed is currently in a tightening mode, this could be a boon to Citi's bottom line.
And lastly, Citigroup's recently approved shareholder return plan will see the company increase its quarterly dividend by $0.13 to $0.45, as well as return $17.6 billion via stock buybacks, which could improve EPS.
In terms of value, Citigroup is a tough stock to beat, which is why it's currently my top bank stock to buy right now.
The best of the big banks
Matt Frankel (JPMorgan Chase): In addition to being the largest U.S. bank by assets, JPMorgan Chase is also the best-in-breed of the "big four" U.S. banks, and its second-quarter earnings report shows why.
JPMorgan Chase generated a return on equity of 14% for shareholders, well ahead of the 10% industry benchmark and the best of the big banks by a considerable margin. It is also the most efficient, with a 56% efficiency ratio, meaning that the bank spends just $0.56 for every dollar it generates in revenue. For big banks, anything under 60% is generally regarded as excellent.
Furthermore, JPMorgan Chase is growing just as well, or better, than most other banks in several key areas. For example, trading revenue -- which has been weak over the past few years industrywide -- beat expectations and grew by an impressive 13%. This is better growth than the two leading investment banks, Goldman Sachs and Morgan Stanley.
Thanks in part to the effects of tax reform, JPMorgan's earnings jumped by 26% from a year ago, and the bank is significantly increasing its capital return to shareholders, including a massive 43% dividend increase set to take effect in the third quarter.
To sum it up, there's little not to like about JPMorgan Chase right now, so for investors looking to add exposure to the financial sector, it's hard to see how you can go wrong with this best-in-breed bank.
Jordan Wathen has no position in any of the stocks mentioned. Matthew Frankel has no position in any of the stocks mentioned. Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.