Now that most banks have reported their first-quarter earnings, we have a good idea about how the sector is doing thus far in 2015. However, some aspects of the banking business are doing better than others, and it can be tough to determine which bank stocks will do well for the rest of the year and beyond. With that in mind, here are three of the best ways to invest in banking right now according to three of our contributing writers.
Jordan Wathen: With the stock market reeling to new highs, now is a good time to start shopping for the relative bargains -- quality stocks at discounted prices. I think JPMorgan (NYSE:JPM) fits the bill of a quality company trading at a less-than-quality price.
Shares of the bank currently trade for about 1.4 times tangible book value, well under the 2.3 times tangible book valuation of Wells Fargo and nearly 3 times tangible book value for US Bancorp. I don't think the sizable discount for JPMorgan is particularly warranted. The bank leads in almost every segment in which it participates, from credit cards, to private banking and investment banking. It's also a formidable competitor in mortgage origination (behind only Wells Fargo) and its wealth management arm is making an impressive showing, adding assets and lucrative fee income that adds to earnings without risking shareholder capital.
Over the next few years its CEO, Jamie Dimon, believes the bank can generate a return of 15% on tangible book value, which normally leads to a valuation of about 2 times tangible book. Last year it earned about 13%, and it recently reported an annualized return of about 14% in the first quarter of 2015. Given this, at 1.4 times tangible book value and 10 times forward earnings expectations, JPMorgan appears to be a high-quality bank trading at an average Joe price.
Matt Frankel: My personal favorite in the banking sector right now is Goldman Sachs (NYSE:GS), which just reported an excellent quarter. Revenues increased in virtually every area of Goldman's business, and even though overall revenue increased by 14%, expenses rose by just 6%. In other words, Goldman's revenue is rising, but the company is spending less for each dollar it brings in.
I like Goldman for two reasons. First, Goldman is an excellent play on the high level of M&A and IPO activity that has been taking place over the past few years. When the market is high, more acquisitions take place (acquires can command higher premiums), and companies are more likely to issue IPOs, since the share prices they can get is higher. And, with the market hitting new highs, Goldman could see advisory and underwriting revenue increase even more.
Secondly (and more importantly), trading revenue is up significantly across the industry as higher volatility and interest rate speculation has led to higher trading volumes. If the Federal Reserve does raise rates as many experts predict, it could increase even more. And, the European QE could provide an added boost.
Goldman derived 51% of its first-quarter revenue from trading, far higher than rivals Morgan Stanley and JPMorgan Chase. So, if the current trend continues, we could see the largest contributor to Goldman's revenues soar.
Dan Caplinger: It's natural for most investors in the financial industry to focus on big national banks, because they get the most attention and have the best-known brand names. But in many cases, smaller regional banks have special opportunities that larger banks can't take full advantage of, and they can earn outsized profits as a result.
For instance, many bank investors fear that when rates start to rise, it will result in big banks having to suffer a higher cost of funds, which could crimp net interest margins. Yet for many smaller banks, limited competition in their markets makes it more likely that customers will stay loyal even without big increases in the interest rates they pay depositors, and that actually gives those banks a chance to expand net interest margins as they reprice their loan portfolios. As Fool analyst Tim Hanson noted last year, banks like Cascade Bancorp and Suffolk Bancorp have rock-bottom costs of funds, and they have the potential to increase their loan books to take advantage of wider net interest margins when they appear.
Of course, smaller banks come with local risk, and so you have to be careful to get to know each bank's particular geographical area. Nevertheless, picking the right small bank can give you much better returns than you'll find from the big names that everyone owns.