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These are obviously simplified definitions. Banks have many other ways to generate revenue. For example, many banks offer safe deposit boxes for lease to their customers, and some make money through partnerships with third-party companies. However, at their core, these are the main ways that banks make their money.
Hundreds of banks trade on the major U.S. exchanges, and they come in various sizes, geographic locations, and focuses. Although there are some excellent choices for investors, here are three beginner-friendly bank stocks that could deliver excellent returns for years to come:
Bank of America has been one of the most impressive turnaround stories in the post-financial crisis era. In recent years, the bank increased its loan portfolio at rates well ahead of its peers, and the company has made major improvements in efficiency while building out its online and mobile technology.
Bank of America's asset quality also is excellent, and although the bank's deposit cost is relatively low, margins have been pressured lately due to the Federal Reserve Board's rate hike cycle that has driven deposit costs much higher. However, Bank of America is an incredibly profitable bank, and could see nice tailwinds in its business as rates normalize and consumer confidence increases.
Bank of America isn't completely immune to economic headwinds. If loan delinquencies spike higher, which is a risk if the U.S. economy weakens, the stock could certainly come under pressure. However, it is in a strong position to weather most storms with a combination of an excellent retail banking operation and an investment bank that can benefit from market volatility.
JPMorgan Chase is hands-down the most profitable of the big U.S. banks, and it's also the largest bank by market capitalization and total assets in the U.S. The bank has operations in just about every area of both commercial and investment banking, and it has done a particularly good job of expanding its credit card and auto loan businesses in recent years. JPMorgan Chase has also done an excellent job of embracing new technologies, and it has made some key investments in financial technology (fintech) companies.
Although the company's Chase consumer banking operation is one of the largest in the U.S., it is worth noting that JPMorgan Chase has the largest investment banking operation of the companies discussed here.
This can be a positive catalyst in turbulent economies since activities such as trading tend to perform strongly in volatile markets, as we've seen during both the financial crisis and the onset of the COVID-19 pandemic. Conversely, in strong economic times, investment banks benefit from a surge in IPO and acquisition activity.
U.S. Bancorp is primarily a commercial bank, with income from loans and other consumer banking products making up virtually all of its revenue. Not only is U.S. Bancorp (known to most Americans as U.S. Bank) focused on consumer banking, but it consistently produces some of the most impressive profitability and efficiency metrics in the sector and has been an excellent dividend stock for investors.
Because it doesn't depend on investment banking, which is generally the more volatile side of the banking business, U.S. Bancorp's profitability and revenue tend to be more predictable and consistent than the other two banks on this list.
However, while it is largely dependent on interest income, and margins have contracted a bit throughout the industry lately, don't worry too much about U.S. Bancorp's ability to make it through the tough times. It was one of the only major banks in the country to remain profitable throughout the 2008-09 financial crisis and has an excellent history of smart risk management.
If you're looking to invest in individual bank stocks, here are a few metrics that you might want to add to your tool kit:
It's also worth noting that net income, or earnings per share, isn't necessarily the best metric to use when evaluating bank earnings. There are certain items included in this (such as money added to loan loss reserves) that aren't actually expenses, as well as one-time items like special assessments by the Federal Deposit Insurance Corporation (FDIC) that can distort the traditional EPS metric and make the price-to-earnings ratio less useful than with most other sectors.
Banks can be a great place to invest, especially in strong economies.
When consumers are confidently spending, and unemployment is low, profits tend to grow and loan defaults are typically kept in check. On the other hand, banks tend to perform quite poorly during recessions and other uncertain times. In investing terms, this means banks are a cyclical business.
There are a couple of reasons why banks tend to perform poorly during recessions and other difficult economic climates. For one thing, they can face a wave of loan defaults if unemployment rises. Also, consumers pump the brakes on spending during recessions, which leads to lower demand for loans.
As previously mentioned, some parts of investment banking -- such as trading -- tend to do better in turbulent times. Banks such as JPMorgan Chase and Goldman Sachs (NYSE:GS) that have large investment banking operations could be helped by tough times, while banks that largely focus on commercial banking, such as Wells Fargo (NYSE:WFC), could be at a temporary disadvantage.
It's also worth mentioning that the United States occasionally faces a banking crisis, and customer panic is a very real risk factor. Consider the 2023 failure of SVB Financial's Silicon Valley Bank. It started when the bank reported that it needed to sell assets unexpectedly at a loss. But the bank collapsed when customers panicked and withdrew tens of billions of dollars from the bank.
Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett is known as one of the best stock investors of all time. During more than 60 years at the helm of the company, Buffett has delivered annualized returns more than double those of the S&P 500, and the investments he's chosen for Berkshire's massive stock portfolio over the years are a good reason for the excellent returns.
If you take a glance at Berkshire's stock portfolio, you'll notice one major trend: Buffett owns quite a few bank stocks. Berkshire owns stakes worth $1 billion or more in a few different bank stocks, including almost 10% of Bank of America, about 21.5% of American Express (NYSE:AXP), and positions in Capital One (NYSE:COF), Citigroup (NYSE:C), and Ally Financial (NYSE:ALLY).
Although it's not necessarily a smart idea to buy any particular stock just because a billionaire owns it (even Warren Buffett), there does appear to be some value in the banking industry if you're a patient, long-term investor who can tolerate some short-term volatility. So if you don't have much exposure in your portfolio, one or more of the rock-solid banks discussed here could be a good fit for you.
Banks can seem like complicated businesses, and they are complicated in many ways. However, the basic ideas behind the banking industry and how these businesses make their money are easy to understand. With that in mind, here's an overview of the different types of banks, some important metrics investors should know, and three great beginner-friendly bank stocks to keep on your radar.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
Company name | Company ticker | Market cap | Dividend yield |
---|---|---|---|
Bank of America | NYSE:BAC | $373.2 billion | 2.06% |
JPMorgan Chase | NYSE:JPM | $822.9 billion | 1.77% |
U.S. Bancorp | NYSE:USB | $75.9 billion | 4.10% |