8 Bank Stocks to Lead the Market in 2018: Goldman

Investors should go overweight in financial stocks, especially banks, based on seven trends, according to Goldman Sachs Group Inc. (GS). These are: rising interest rates, increased returns of capital to shareholders, continued deregulation, strong M&A advisory fees, improving net interest margins, loan growth, and attractive valuation and growth. Among 17 banks analyzed in Goldman's U.S. Weekly Kickstart report dated May 4 are: Bank of America Corp. (BAC), Wells Fargo & Co. (WFC), Citizens Financial Group Inc. (CFG), Regions Financial Corp. (RF), Comerica Inc. (CMA), KeyCorp (KEY), PNC Financial Services Group Inc. (PNC), and SunTrust Banks Inc. (STI).

Key Statistics

Using closing prices on May 9, the year-to-date gains, the implied gains to Goldman's price targets, and the projected increases in returns of capital to shareholders during the 12 months ending June 2019 for these stocks were:

Returns of capital include both dividends and share repurchases. Through May 9, the S&P 500 Index (SPX) was up by 0.9% YTD. The gains to target in the report were based on May 3 prices. Those in the table above were adjusted to reflect changes in prices from May 3 to May 9. (For more, see also: Top 4 Bank Stocks for 2018.)

Attractive Valuations

The report indicates that, based on the last 10 years of history, the financial sector trades at discounts to the broader S&P 500 based on forward P/E ratio (12.7 times earnings vs. 16.3 times), price to book (P/B) ratio (1.5 times book vs. 3.2 times), and PEG ratio (0.9 times growth vs. 1.0 times). Looking at the 10-year averages for these metrics, the current relative valuation of financial stocks compared to the full S&P 500 is considerably lower for P/E ratio and PEG ratio, and only marginally higher for P/B ratio.

On the basis of price to tangible book (P/TB) ratios, the stocks listed above range from 1.6 times tangible book for Citizens to 2.1 times for SunTrust. "Buybacks will lower the equity base and support a higher P/TB ratio than the current 2.0x," the report says, referring to the median for the 17 banks analyzed. Moreover, risk has been lowered, given that "Financials operate with much lower leverage in the past." However, less leverage has resulted in a low median return on tangible equity (ROTE) of 13% for the 17 banks. (For more, see also: 4 Bank Stocks to Outperform in 2018: Oppenheimer.)

'Anemic Loan Growth'

"The major investor pushback we receive on our overweight recommendation for banks relates to the perceived anemic loan growth," the report acknowledges. For the top 25 domestic banks, estimated year-over-year loan growth of 2.6% for 2016 is the lowest since 2014, but is dragged down by a 1% contraction at Wells Fargo. On a positive note, however, "the drivers of loan growth are trending in a positive direction (increased capex plans, increased M&A, and low cash balances)."

Note on M&A

While the report mentions M&A activity as one of the trends that will drive bank revenues, profits and stock prices upward, this is not in the context of mergers among banks. Instead, the authors are looking at a growing wave of "corporate actions" across industries, and anticipate that this will produce increased advisory fees for banks, as well as increased lending activity, as noted above.