What are we looking for?
U.S. bank stocks poised to see increased profitability under possible changes to the Dodd-Frank Consumer Protection Act.
In 2010, U.S. President Barack Obama signed the Dodd-Frank Act, which was aimed at providing enhanced regulation of U.S. banks in order to protect consumers. After the financial crisis, U.S. legislators felt that the banks had taken unnecessary financial risks and that taxpayers were being asked to pick up the bill for their mistakes. Among other things, Dodd-Frank's Volcker Rule limits U.S. banks from proprietary trading, in which deposits are used for trading in the bank's own accounts.
Since taking office, President Donald Trump has repeatedly expressed his belief that there is too much regulation of the financial-services industry and has promised to reduce it. Recently, he asked the U.S. Treasury Department to lead a review of financial-industry legislation with the aim of streamlining or eliminating some legislation. Many market watchers believe Dodd-Frank and the Volcker Rule may be among the first to go – this could lead to increased profitability in the capital markets divisions of U.S. banks.
The screen
We will be using Recognia Strategy Builder to search for U.S. banks with strong profitability and reasonable valuations today.
We begin by setting a minimum market capitalization threshold of $15-billion (U.S.) to focus on the largest companies in the sector. To find stocks with strong profitability for shareholders, we will screen based on return on equity ratios of 6 per cent or more. Return on equity measures how effectively a company is at converting invested capital into income. Return on equity is one of the most scrutinized valuation metrics in the banking industry.
To ensure we don't overpay for our investments, we will select stocks with reasonable valuations based on a price to book ratio of 1.6 or less and a forward P/E ratio of 16 or less.
More about Recognia
Recognia is a global leader in automated quantitative analysis and engagement solutions for retail online brokers and institutions. Recognia's product suite provides actionable trading ideas based on technical and fundamental research covering stocks, ETFs, indexes, forex, options and commodities.
What did we find?
The largest company on our list is JPMorgan Chase, the largest U.S. bank and the third-largest in the world by assets. JPMorgan has significant capital markets operations which have traditionally been a strong contributor to earnings. Chief executive Jamie Dimon is also a close adviser to Mr. Trump and has been critical of the Volcker rule in the past. Two weeks ago, JPMorgan announced first-quarter results that beat analyst expectations handily for both revenue and earnings.
The best price to book valuation on our list belongs to New York-based Citigroup. With a price-to-book ratio of 0.81 and a forward P/E ratio of 12.9, Citi looks well valued compared to its peers. One of the underlying reasons for this is the low return on equity at just 6.6 per cent.
The traditional heavyweight of the U.S. capital markets arena is financial giant Goldman Sachs. No bank would likely benefit more from the repeal of the Volcker Rule than Goldman Sachs. On April 18, the company announced a rare miss of analyst expectations in its first-quarter results. Investors were not impressed and drove the stock down almost 5 per cent the next day.
The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Recognia Inc. in respect of the investment in financial instruments. Investors should conduct further research before investing.
Peter Ashton is vice-president of retail and self-directed investing at Recognia Inc.
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