Is This Bank Cheap According to Graham?

I recently spent some time dissecting The Intelligent Investor, Benjamin Graham's seminal book on value investing. Along the way, I talked about the Graham number as a means of valuation when it comes to stocks.  The formula is pretty straightforward: Multiply earnings per share by book value per share, then multiply that by 22.5 and, finally, take the square root. The result, in dollars, is the Graham number.

However, a quick check can help determine whether or not a company might be worthy of a look using the teachings of Graham. He said that in an ideal situation, the P/E ratio and P/B ratio multiplied together should not exceed 22.5, with a maximum P/E ratio of 15 and P/B ratio no greater than 1.5. With that in mind, I screened the stocks of the S&P 500 that met those requirements and was presented with 56 companies. I will be making a CAPScall on most of these companies after comparing them to competitors and their current value in relation to their Graham numbers. Up next is regional bank leader Fifth Third Bancorp (Nasdaq: FITB).

Who are they?
Fifth Third Bancorp is a regional bank based in Cincinnati. The bank has spent much of the last few years improving its credit quality, and it finally showed last year, with nonperforming assets reaching their lowest levels since the first quarter of 2008. While its dividend is not quite back to pre-crisis levels, it is still yielding a modest 2.3%, with plenty of room to grow due to a payout ratio of only 24%. Finally, it is a favorite of our banking expert, Anand Chokkavelu, and it's a part of his Rising Star portfolio, returning 41% since he added it back in August.

What's it worth?
When compared to banks of similar market cap, it has the second most room to grow, behind the dramatically cheaper KeyCorp (NYSE: KEY):

Source: Yahoo! Finance and author's calculations. TTM = Trailing 12 months. MRQ = Most recent quarter.

All but Northern Trust trade below their Graham number. The New York bank is feeling the pinch of low interest rates, prompting it to cut 700 jobs in an attempt to boost profits. SunTrust, one of the worst-performing banks of 2011, could see lending come back to life. KeyCorp, which is also a part of Anand's portfolio, was in the news recently for publicly opposing the Volcker Rule placed on banks. Nevertheless, its above-average performance could make it an interesting choice among smaller banks. Finally, despite an earnings hiccup caused by a one-time charge, M&T Bank saw a 12% increase in earnings during 2011 and has been identified as a bank to own in 2012.

Accountability time
As another regional bank with some room to grow, Fifth Third joins Huntington Bancshares as a bank that will continue to improve along with rest of the financial sector. Therefore, I will be placing a "thumbs up" over on my CAPS page in order to track this call and keep myself accountable. I will also be adding Fifth Third Bancorp to My Watchlist to stay up to date on anything that may cause me to change my opinion of the company.

Fifth Third Bancorp may not be the only opportunity to profit from regional banks. Many investors are interested in bank stocks, including Warren Buffett himself. Our special report, "The Stocks Only the Smartest Investors are Buying," explains why Buffett would buy one bank in particular, were he a smaller investor. Click here to get your free copy today.