Four U.S. bank stocks in good shape to grow

However, increasing prospect of Fed rate cuts in the second half of 2019 may be making some investors nervous. If the U.S. central bank does reduce its benchmark interest rate, for the first time since 2008, the move could erode some of the near-term profitability of banks driving their stocks lower. On the flip side, though, any pullback in stock prices would create attractive entry points for long-term investors looking to begin or broaden exposure to the banking sector south of the border. Stocks of the following well-capitalized U.S. banks, all of which passed the latest Fed stress test, are trading below or close to their fair value and offer some margin of safety valued by prudent investors.

Wells Fargo (WFC) is one of the largest U.S. banks, with approximately US$1.9 trillion in balance sheet assets. The bank has leading share and operations in many of the key areas in which it competes including community banking, wholesale banking and wealth management. It is also one of the largest U.S. issuers of credit and debit cards.

“Wells Fargo remains one of the top deposit gatherers in the United States, even after years of negative headlines related to the bank’s scandals,” says a Morningstar equity report, noting that the lender’s strategy rests on “deep customer relationships, sound risk management, and operational excellence.”

A robust branch network in the U.S., dominance in the middle-market commercial space, and strong advisory network, help the bank generate more revenue per dollar of assets than most peers over time. “Given the bank’s higher capital levels since the crisis, the increasing importance of scale and scope with changes in technology, and robust fee income, we believe Wells Fargo will consistently earn returns that exceed its 9% cost of equity through the cycle,” says Morningstar equity analyst, Eric Compton, who estimates the stock’s fair value to be US$59.

Wells Fargo’s sustainable competitive advantage springs from cost advantages and switching costs, adds Compton.

Capital One (COF) is a diversified bank offering a wide range of financial products and services to consumers including small businesses, retail and corporations. The bank specializes in three businesses: credit cards (42% of loans), consumer lending (31% of loans), and commercial banking (28% of loans). Its credit cards segment accounts for approximately 59% of income.

“Capital One is one of the best-run banks and does not receive the respect it deserves,” says a Morningstar equity report, noting the company’s strategic capital allocation is often misunderstood by investors who’re “missing the value of these investments.”

This bank’s success is widely attributed to a sharp focus on technology, operations and organic growth. However, “Capital One has periodically created significant value by acquiring businesses opportunistically and, most important, at attractive prices,” notes Compton, who puts the stock’s fair value at US$133. “Using its patient acquisition philosophy, Capital One has become a stronger, diversified consumer lender.”

Years of investment in IT, rewards programs, advertising platforms, and well-timed acquisitions, have created cost advantages that underpin the firm’s competitive advantage. “In addition, Capital One benefits from switching costs as cardholders do display mild loyalty after being issued a card [which] results in a highly balanced loan portfolio,” adds Compton. 

Goldman Sachs (GS) offers investment banking, institutional client services, investing and lending, and investment management services worldwide. The firm generates over half (60%) of its revenue in the Americas, 15% from Asian accounts, while 25% comes from Europe, the Middle East, and Africa.

Goldman is undergoing strategic changes geared towards increasing its market value. More recently, the company’s increased its focus on investment management business, which now accounts for 20% of net revenue compared with 11% to 12% before 2008. “Investment management is a relatively stable, high-return-on-capital business that is well suited to the current regulatory environment,” says a Morningstar equity report.

Additionally, Goldman is making a greater push into banking with digital lending and purchase of deposits from GE Capital. As a result, loans receivable are now north of US$80 billion, with deposits exceeding US$150 billion. “Overall, we believe there’s strong synergy with lending to wealth management and corporate clients,” says Morningstar sector director, Michael Wong, who pegs the stock’s fair value at US$257.

While digital banking doesn’t add meaningfully to the firm’s competitive advantage, a combination of “high-growth digital banking and more-stable investment management and traditional banking could spur investors to look at Goldman Sachs in a more favourable light,” argues Wong.

Banking behemoth JPMorgan (JPM) is the largest financial institution in the U.S. by assets (US$2.5 trillion) and tends to have leading share and operations in almost all of the areas it competes. The bank operates four major segments--consumer and community banking, corporate and investment banking, commercial banking, and asset and wealth management.

“With leading investment bank, commercial bank, credit card, retail bank, and asset and wealth management franchises, JPMorgan is truly a force to be reckoned with,” says a Morningstar equity report.

Few other banks have quite as successfully executed a strategy combining scale, diversification, and sound risk management as JPMorgan. “Even the best-managed banks are not immune to the occasional stumble, but JPMorgan has managed to seemingly put all the pieces together in a more cohesive and less error prone way than peers,” says Compton, whose US$110 fair value estimate for the stock indicates it’s currently fairly valued.   

JPMorgan, with about US$1.5 trillion in deposits, benefits from a nearly unrivalled combination of scale and scope. “The scale and multiple revenue sources allow the bank to increase customer switching costs, generate more revenue per risk-weighted asset than smaller peers, and also have a larger percentage of revenue come from fees,” notes Compton, adding that these attributes make JPMorgan “one of the fiercest competitors.”