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The Case For Adding Bank Stocks

Looking at the valuations of defensive stocks vs. cyclical stocks, the best gains may come from cyclical stocks. The best forward returns are likely to come from bank stocks such as JP Morgan Chase and Wells Fargo. These stocks come with more than their fair share of risk.  However, the potential gains prove they are worth it. Wells Fargo is expected to earn 4.02 in 2014. Given its current price of 46.68, the expected PE ratio is (46.68/4.02) 11.61. Looking at the valuation history of Wells Fargo over the last five years below, you can see that it is currently trading at the low end of its valuation range.

WFC PE Ratio (TTM) Chart

WFC PE Ratio (TTM) data by YCharts

Assuming that Wells Fargo reaches a valuation of 15 times earnings, the expected value by the end of 2014 is (15 * 4.02) $60.30. This represents a return of ((60.30-46.68) / 46.68) 29.17%.

 

JP Morgan Chase shows a similar enticing return over the next year. JP Morgan Chase is expected to earn 5.96 in 2014. Given its current price of 58.78, the forward PE ratio is (58.78/5.96) 9.86.  The valuation history of JP Morgan Chase over the last 5 years below shows that it is also trading at the low end of its valuation range.

JPM PE Ratio (TTM) Chart

JPM PE Ratio (TTM) data by YCharts

Assuming that JP Morgan Chase trades at 13 times its expected 2014 earnings, the expected price at the end of 2014 is (5.96 * 13) $77.48. This represents a potential return of (($77.48 – $60.30) / $60.30) 28.85%.

The current backdrop of an improving housing market and job market along with rising interest rates should be beneficial for bank earnings going forward.  Wells Fargo and JP Morgan Chase earn fees that go along with home loans and earn more money from deposits as interest rates rise. Even more importantly, it is not likely that these banks will be faced with major defaults on loans as the economy improves.

Given the attractive valuations of banks along with the improving US economy, these stocks make for compelling investments in 2014.

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