After the seemingly nonstop rally in the markets over the past few months, a pullback was inevitable. As far as bank stocks go, a combination of reasons, including some not-so-hot earnings reports and weakness in the overall market, has caused a significant pullback in most of the big financial stocks.
However, despite how most investors feel, pullbacks are not to be feared. On the contrary, a pullback in an already cheap stock should be looked at as a buying opportunity. Let's take a look at some examples, why I say they're "cheap," and finally, a good way to approach market pullbacks.
Cheap bank stock No. 1: JPMorgan
JPMorgan Chase (JPM -0.73%) has lost 8% of its value since its peak a couple of weeks ago. Ignoring legal costs, JPMorgan really didn't perform too badly this past year. However, legal costs have put a big damper on the company's post-crisis recovery and future expansion efforts. Over the past year, JPMorgan has agreed to pay a record $13 billion settlement over its sale of mortgage securities, as well as more than $2 billion for its role in the Madoff scandal.
Personally, I'm glad all of the settlements happened. The bank had been strategically setting aside money to cover them, and with all of the legal drama over, JPMorgan can shift its focus to the future.
Aside from the legal drama, JPMorgan's business is doing pretty well. Private banking revenues rose 11% from last year, and the company has increased the size of its asset management business, with total client assets of $2.3 trillion, 12% over last year.
No. 2: Morgan Stanley
Morgan Stanley (MS -2.21%) has dropped by over 9% in the past week alone, despite the fact that the company beat estimates when it reported earnings on January 17.The pullback could simply be the result of a very long, very successful run in the share price.
Morgan Stanley's share price rose 64% in 2013, which makes it the best performer out of the 10 largest investment banks in the world. The company has stated that it intends to double its return on equity this year, which would mean an ROE of about 10%. This is a very achievable goal, and in fact, Morgan Stanley's ROE has climbed above 10% many times in the past, even after the financial crisis.
MS Return on Equity (TTM) data by YCharts.
The big loser: Citigroup
One of the worst performers lately, Citigroup (C -1.99%) has lost nearly 11% of its value since hitting a peak of $55.17 on January 15. Despite the big drop in share price, Citigroup is and has been for a while one of the most attractively valued stocks in the entire market.
While it is true that Citigroup's earnings disappointed analysts, the company still earned 21% more than last year, and stated that it is well on track to meet its turnaround goals by 2015.
The company actually trades at a 10% discount to its tangible book value, meaning it trades for less than the assets of the business are worth, a rarity in Citigroup's history. I believe Citigroup's share price justifies any risks associated with owning the stock.
How to approach market pullbacks
I like to think of pullbacks as great times to buy the stocks I already thought were cheap. When there hasn't been a significant pullback for a while (as was the case up until a couple of weeks ago), I like to ease into a new position with the intention of buying more if I can get it for a bargain.
For example, let's say an average position size in my portfolio is $10,000, and that I feel Citigroup is cheap and want to add it to my holdings. A full position would be around 200 shares at the current price, so if there hasn't been much downward price action for a while, I may buy 50 shares to start.
If the market pulls back, and I can buy more at a cheaper price, I may add another 50 or 100 shares, depending on the circumstances, and will continue adding at cheaper levels until I have all of the shares I want.
Foolish final thoughts
While this is how I like to approach pullbacks, as investors, we are all different. My point here is not to give you a set-in-stone method for trading market pullbacks, but rather to change your attitude when you see your favorite stocks in your portfolio drop by 5%-10%, especially if the rest of the sector is doing the same.
You wouldn't be fearful if you walked into your favorite clothing store and saw there was a great sale going on, would you? The same logic applies here!
