A blue chip stock is one that carries a certain cachet, as a stock of a company that's stable, well-capitalized, consistent, steady, established, high-quality, and a market leader with a great brand -- among other descriptors.
Blue chip stocks have become significantly more popular over the past 18 months or so, as investors have been attracted to their stability in a time of major market turmoil. While there are a lot of excellent blue chips out there, one in particular is a screaming buy because of its low valuation. Here's why Bank of New York Mellon (BK 0.24%) is a bargain right now.
Roots that date back to Hamilton
The main thing to understand about Bank of New York Mellon, or BNY Mellon, is that it isn't a traditional consumer bank like most of its big bank competitors -- it is a custody bank.
Custody, or trust, banks primarily hold money and assets for institutional investors -- like corporations and asset managers, including mutual funds and exchange-traded funds (ETFs) -- for safekeeping. They also service those assets by handling fund accounting, inflows and outflows, securities lending, and transaction clearing and treasury services. In addition, BNY Mellon has an asset and wealth management arm of its own.
BNY Mellon is the largest custody bank in the U.S., with $47 trillion in assets under custody (AUC) as of March 31. Its closest competitor, State Street, has about $38 trillion in AUC. Its roots run deep as one of the first banks in the country, and the predecessor Bank of New York was founded in 1784 by Alexander Hamilton. One might argue that you don't get much more blue chip than that.
As a custody bank, it generates most of its income from fees charged for those services -- about 72% -- with the rest coming from interest earned on its assets. This has been a benefit for BNY Mellon in these tumultuous times, as its first-quarter earnings showed.
Its AUC actually increased 2% in Q1, and revenue was up 11% year over year to $4.4 billion. Fee revenue was little changed, while interest income jumped 62% year over year. Earnings rose 30% in the quarter from a year earlier, with net income of $976 million.
Deposits were also fairly stable in the quarter, up 1% from the previous quarter after a surge of deposits following the bank collapses in mid-March. Chief Executive Officer Robin Vince explained on the Q1 earnings call that the majority of BNY Mellon's deposits are operational, meaning they are deposits from large institutional clients that use other services with BNY Mellon. This makes them stickier -- or less likely to leave -- and they also don't carry the same costs as other deposits.
So overall, BNY Mellon benefits from having stable fee income, less credit risk and lower provisions for loan losses, and less expensive deposits than traditional banks.
"We've been a port in the storm for our clients in periods of stress over that time and recent weeks have been no different as we've helped our clients to navigate the volatility in markets with our strong balance sheet and broader liquidity solutions," Vince said on the earnings call.
No longer on the Buffett table, but still a good value
BNY Mellon made some news last month when it was revealed that Warren Buffett and his team at Berkshire Hathaway had entirely exited their position in the stock, after holding it for 13 years. They had been slowly winding down the position over the past year or so, but in the first quarter they got out completely. Buffett's moves are closely watched by investors, and after the filing posted on May 15 that he had dumped BNY Mellon, the stock price dropped a few percentage points.
The move came during Q1, when banks were under fire after two major ones collapsed. Buffett may have seen better options elsewhere in the banking sector, as he added to positions in large banks like Bank of America, Citigroup, and Capital One. The team may have also been concerned about deposit pressures, even though they did not seem to materialize for the bank -- at least not yet.
BNY Mellon's valuation metrics did creep up in the first quarter, so Buffett and Co. may have found better values elsewhere. But since the end of Q1, BNY Mellon's valuation has come down, and it looks like a good buy at the current level.
The forward price-to-earnings ratio is down to 8.7, from 9.1 at the end of March and 10.5 a year ago. Its price-to-book ratio has fallen to 0.95, which means it is trading below its book value -- a sign of an undervalued stock. Its P/E-to-growth ratio, or PEG ratio, is an extremely low 0.54. This measures its price relative to its expected five-year growth rate, and anything under 1 means a stock is undervalued. The lower it is under 1, the more undervalued it is.
BNY Mellon is not a stock where you should expect to see blowout growth. But, as the CEO said, it serves as a safe port in the storm and a stable defensive stock in a portfolio. And right now, it's a bargain.
