Financial Stocks That Possess Upside Prospects

Analysts at C.J. Lawrence have said that financial stocks are a buy following the market correction earlier in the month. During that market downdraft there was a decline of 11.3% in the Standard & Poors Financial Sector Index. In the first two months of 2018 the EPS estimates of the sector hav increased by an average of 10%. As it is a period of economic expansion the low earnings multiples have seen the index at historic lows.

The attractiveness of financial sector stocks has been improved by the fact that the industry has been recording double-digit returns with regards to equity. The financial sector stocks have also recorded an improvement in margins.

Though interest rate- and inflation-relation volatility is not going away anytime soon, the steepening yield curve, an economic boom and higher rates are all good for financial stocks. Some of the financial stocks that are in the sights of most analysts include Goldman Sachs Group Inc (NYSE:GS), JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc (NYSE:C) and Wells Fargo & Co (NYSE:WFC).

Consensus outperform rating

With regards to Citigroup 31 Wall Street analysts have a consensus outperform rating on the stock. The level of shorts in the stock is currently just a little over 1%. About 18 analysts covering the stock have buy-equivalent rating on Citigroup and the sentiment is expected to get more bullish. The price target place on Citigroup is $84.34 and this would suggest a gain of 10.58% from a recent closing price. In its most recent reported quarter the market was taken by surprise when Citigroup earned approximately $1.28 per share compared to the consensus estimate of $1.19.

Recently directors of Citigroup raised the annual compensation of the bank’s chief executive officer, Michael Corbat, by 48% to a figure of $23 million. Per a filing with the market regulator the directors said their decision to raise Corbat’s pay was motivated by the fact that progress had been made with regards to meeting new targets. A year ago the annual compensation of Corbat was reduced by 6% to a figure of $15.5 million following the missing of financial performance targets by the lender. At the time around 30% of shareholders expressed disapproval with his pay.

Market overreaction

Analysts at Keefe, Bruyette & Woods have said that the fall in price with regards to the shares of JPMorgan Chase earlier in the month was an overreaction. The analysts at the Wall Street firm, which has an accuracy rate of 68% with regards to the commercial banks sector, have consequently assigned an outperform rating on the stock.

According to Keefe Bruyette though macro risks that include rising wages as a result of growth in jobs, prospects of high inflation and rising bond rates very much exist, high-quality bank franchises such as JPMorgan Chase stand to gain and outperform. Keefe Bruyette has consequently placed $127 as the price target for JPMorgan Chase.

The Wall Street firm has also said the lender is trading at around 11.3 times the profits it is expected to earn two years from now. That’s a long way off though and currently JPMorgan Chase is trading at 17.7 times trailing earnings. Among the big banks this figure is in the middle of the pack as it manages to be cheaper than Goldman Sachs and Bank of America. Goldman Sachs is trading at 27.8 times earnings while Bank of America is trading 19.8 times earnings. The cheapest among the biggest banks is Wells Fargo which is trading at 13.9 times trailing earnings.

Expected upside

Currently Goldman Sachs is enjoying high shareholder returns, solid growth outlook and low valuation. All these factors are expected to lead to an appreciation in the price of the share in the future especially in light of the fact that the Trump administration has rolled back regulations that were stifling the industry. Additionally the higher interest rates that are expected to accompany a rise in the inflation rate are expected to benefit large Wall Street firms. Goldman Sachs is on record to admitting that low trading activity has hurt its revenues.

In 2017 revenues from fixed income, currency and commodities (FICC) at Goldman Sachs went down by 30%. Despite that Goldman Sachs managed to increase its revenues highlighting the fact that banks are operating in a very positive environment. Barring the impact of the reduced revenues from fixed income, currency and commodities Goldman Sachs would have raised revenues by 12% year-over-year.

Part of the reason for the decline in FICC trading has been the market complacency and record low volatility witnessed in 2017. This is because when the movements in the market are tiny clients of Goldman Sachs, as well as other Wall Street banks, see no reason to make changes in their investment portfolios.

ROE and ROA

The consensus call of analysts with regards to Wells Fargo is currently 2.8. Analysts numbering 6 have a buy rating on the stock while 13 have a hold rating and 2 have placed a sell rating. The price target of the analysts with a buy rating on Wells Fargo is $64.27 per share. This would mean the share stands to gain by 9.28%.

According to Yahoo Finance the return on equity for Wells Fargo is 11% compared to 9.6% for JPMorgan Chase, 6.8% for Bank of America, 5.1% for Goldman Sachs and 2.8% for Citigroup. Thus Wells Fargo outclasses all the major banks with regards to the return on equity metric. With regards to return on assets Wells Fargo also edges the other four major banks as well. In this metric the return on assets for Wells Fargo is 1.2% while that of JPMorgan Chase is 1%. Bank of America has a return on assets rate of 0.8% while Goldman Sachs’ is 0.5%. Citigroup comes in at the tail end among major banks with a return on assets rate of 0.3%.

While Wells Fargo may seem like the better buy the problem with the bank is the reputational risk it carries following a series of scandals that have engulfed the San Francisco, California-based financial institution. Reputational risk is however harder to quantify and caution is always urged in such circumstances.

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