Looking closer at the largest financial stocks

by Wayne Ferbert on October 2nd, 2012

The Financials sector has had a nice 12 month run. You might remember that the sector was volatile at the end of Summer 2012 thanks to the debt crisis in Europe. The sector has recovered nicely since then with a one year return in the XLF of 40%. Not too shabby.
Of course, the financials had a lot of room to run. It was the most beat down sector in the 2008-09 credit crisis. In fact, it is still the most beaten down sector BY FAR when valuations are compared to he highs in late 2007.
So, the question is: how much more room does it have to run and are there any buying opportunities in that sector? To answer these questions, we examine the underlying components of the sector ETF. In looking at the components of the XLF, the top 20 holdings make up 66% of the value of the overall fund. These are the large and super large caps in the fund.
When you look closely at the price of these top 20 firms, you notice that most of them are not too close to their 52 week high – at least when you consider the entire high-low range for the 52 weeks. I like to split the 52 week high-low in to the 4 quadrants – low, mid-low, mid-high, & high. Of the 20 companies, 15 of them fall in to the High quadrant – meaning they are nearing the 52 week high.
Of these 15 in this top quadrant, they are still on average 15% below their 52 week high – so they have a little bit of room to run. But they are starting to feel a little bit top heavy. But another 15% up move would still feel great!
On the positive side, of the top 20 firms, Morningstar has a 4-Star rating on 13 out of the 20. Six other stocks have a 3-star rating and the last one is under review. So, on average, Morningstar has a positive view on the potential for many of these firms.
I think Morningstar has a very objective approach to valuation and its non-conflicted status gives the M-star rating more credibility than Wall Street.
Of the 4-star firms in the top 20, several stand out: Wells Fargo (WFC), Berkshire Hathaway (BRK.B), JP Morgan Chase (JPM), Citigroup (C), Goldman Sachs (GS), Bank of New York Mellon (BK) & Morgan Stanley (MS). Of these firms, the ones trading at the largest discount to their 52 week high are: MS, BK, C, JPM, & GS.
If you added the 21st company on the list, BlackRock (BLK), you’d have another 4-star rated company that is trading at a solid discount to its 52-week high – as BLK is trading at 57% of its 52-week high.
Of this whole group, only C & JPM are trading at a TTM PE of less than 10.
I am intrigued by Goldman Sachs, JP Morgan, & Blackrock. I think that all three are best of breed within their given businesses in the financial sector. You could be very comfortable owning any of these three firms.
But as usual, we want to be paid to own them. So, I like the idea of selling puts that are just OTM to get forced to buy them at a lower price. And if you don’t get triggered, then you pocket the premium for your efforts.
In particular, I like entering BLK and GS by selling OTM puts. I think JPM already gave you the chance to own at a discount earlier this year when they announced the one time trading losses. If JPM would pull back again, I would look for an entry.

The November puts have a lot more premium in them because they carry the election risk and earnings announcement risk. But I still like them.
BLK puts for November at the $165 strike are trading at $2.15. With 7 weeks until expiration, that is about a 1%+ premium to get paid to take the risk of ownership at $165 per share. BLK currently is trading at $176.55 – so, the $165 price represents a 6.5% discount from the current price. I like that trade-off for a best of breed company.
For GS, I think you need to set your comfort level a little lower. The November puts at $105 pay a little over $1 or about 1% premium you collect. But the $105 price is a $12.75 discount from the current price – or a 10.8% discount to the current price of the stock. Given that GS is a little closer to its 52 week high than BLK, I want a little more margin for error.
GS & BLK are best of breed firms that can be owned confidently in your portfolio if you are looking for any ‘Inner Guru’ picks!

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