Bulls vs. Bears: Are Banks Stocks Safe?

Joel Anderson  |

One area where investing experts appear to be conflicted is whether or not the attractive prices available for many of the most prominent financial companies in the world make them a buying opportunity or not.

After five years of chaos, from the bailouts to the European debt crisis, many major banks have seen their share price take a beating. Since early 2007?

JP Morgan (JPM) is down over 25 percent. Goldman Sachs (GS)? Down over 45 percent. Morgan Stanley (MS)? Off 70 percent. And, brace yourself, Bank of America (BAC)? Try an 85 percent loss in its market cap from its peak, taking the company's valuation from over $550 billion to just over $80 billion.

The news is equally bad in Europe where the debt crisis has compounded issues in an even more acute fashion. In the last five years, ING Groep (ING) is off almost 80 percent, Deutsche Bank (DB) has lost almost 68 percent, Barclays (BCS) is down 75 percent, and Lloyds (LYG) has plummeted some 95 percent.

So it seems as though one of two things must be true: either these banks were drastically overvalued five years ago, or the current economic crisis has hit the banks hard and, as the economy slowly recovers, much of that share price could come back. This particular question is an important one for investors as billions of dollars could be on the line and, predictably, a number of analysts fall on either side of this issue. While the collapse of the share prices and market value of some of the most established of financial institutions seem to present a historic opportunity for investor value, that doesn't necessarily mean that these banks represent an easy investment option.

Those bullish on major bank stocks have a fairly simple perspective. Simply put, the massive loss of market cap by these formidable institutions represents a buying opportunity. In many, if not most cases, the price-to-book ratio, a favored valuation for believers in Benjamin Graham's value investing strategies, is extremely favorable.

The banks have considerable assets at their disposal despite major losses and as long as the economy in the United States continues to improve steadily, it stands to reason that these banks will continue to grow.  What's more, with the worst days of the banking crisis appearing to be in the review mirror (provided that Greece manages to make a deal in the next few days), the risks of massive losses on sovereign debt should begin fading away (famous last words, it's important to note, throughout 2011).

All told, if these banks recover even half of the share value that they lost, they should make for extremely appealing buys. Berkshire Hathaway's (BRK.A) Warren Buffett seemed to think so, pumping $5 billion into Bank of America and Goldman Sachs.

"Banks face so many issues, both in the near-term and on a long-term secular basis, that putting shares away, even now when they look cheap, could be hazardous to your wealth and your mental state," said Shah Gilani, Capital Waves Strategist last October. There are reasons to question the simple view that banks are bargain buys due to eventually rebound at least partially from the sell-off surrounding the housing and European debt crises.

For one thing, as Rich Smith, a contributor for The Motley Fool observed in November of last year, price-to-book ratios rely on valuing assets and liabilities and many of these banks have large holdings that are difficult to precisely value.

"Are banks cheap? Are they -- as the above table certainly makes it appear -- so cheap that it's now ridiculously easy to make money by investing in them? If this were a simple matter of 'buy at 0.5 times book value, wait until the stock rises to the average Dow valuation of 2.5 times book value... and collect a 400% profit,' then the answer would clearly be yes. But consider: What is it really that goes into a bank's book value that makes the company's net asset value look so high while its stock price is so low? Net asset value, as you know, is what you get if you take a bank's assets and subtract its liabilities. Therein lies the problem -- those "assets" may not be all they're cracked up to be, and those "liabilities" may be greater than they seem."

There's also the very real concern that the issues in Europe will continue to cast a pall over any potential investments. Even if Greece manages to cut a deal that will save the bailout plan, there's still a great deal of serious concerns for the future. What's more, years of planned austerity in countries like Italy and Greece where economic conditions are already poor has the potential to mean a long-term economic downturn. Many economists are predicting a lengthy recession for Europe, which could mean that European investment banks will continue to struggle producing revenue for the foreseeable future.

While the long term wisdom of either approach to the banking industry's current health can't be established yet, January certainly appears to show signs that the bulls might have been right. Many bank stocks have rebounded in early going in 2012, with Bank of America up over 40 percent, Morgan Stanley rebounding just under 34 percent, and Goldman Sachs is up almost 30 percent.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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