This week was a big week for investors not just because the market was up based on the Federal Reserve's stress test, but also because of what this means to the economy and, from my point of view, investors.
Even Jim Cramer of "Mad Money" has gotten on board with the banks now and is saying what a great buy. Too bad he and many others were saying stay away three to six months ago when I was saying the numbers looked great and to step in and buy. I didn’t know when they would turn around, but by being patient and buying, investors have gained around 30 percent on the right bank buys, the ones with the strong numbers. Sorry you missed the buy call, Cramer.
So is it too late now to get in? Did you miss the gain? Yes and no. You missed buying the right banks at great buys, but there are still some good buys left for the long-term investor with a 12-24 month time horizon. Before I give you an example of a bank with some good numbers for you to research, let me explain a little more on what happened Tuesday.
The previous round of tests was performed back in 2009, which doesn’t seem that long ago but it was. The stress test this time was more rigorous than back in 2009. To pass the current test, the bank had to prove it could survive if unemployment were to climb to 13 percent. I checked with the Bureau of Labor Statistics run by the U.S. Department of Labor, and we have not had a 13 percent unemployment rate since the Great Depression. Back in 1982, unemployment rose to 10.8 percent because of the extremely high interest rates.
The bank must also be able to withstand a 50 percent drop in the stock market, which from current levels would put the Dow back down to about 6,600. This is about the low the Dow reached in the spring of 2009. But think about what was happening then — we had Bear Stearns folding, Shearson Lehman Brothers closing its doors and many other banks that were highly leveraged on the brink of collapse.
Fast-forward to 2012 and the banks are much stronger, and with a strong banking system the economy has a stable environment to grow and no reason for a 50 percent drop in stock prices. The last test is banks must be able to withstand an additional 21 percent drop in housing prices. Housing prices have already dropped about a third from the highs back in 2006 and 2007, and another 21 percent drop from here would be a total decline of roughly 48 percent from the highs.
While I have stated many times that I don’t think investing in real estate going forward will give you the best return on your investment, I don’t think a 21 percent decline is likely. Housing starts are at lows not seen in more than 35 years, and this has helped housing inventories decline from a peak of around 4.5 million reached back in 2007, to fewer than 3 million homes now. The percent of average household personal income needed now to buy a home is around 10.3 percent. This number peaked around 40 percent back in the early 1980s and has not been less than 11 percent in more than 35 years.
In other words, supply is falling and demand is and will be increasing, which should stabilize prices and make a 21 percent drop pretty much a fantasy.
This should tell you that we are on the road to recovery. Yes, there will be bumps in the road, but 15 of the 19 largest banks passed this difficult test. By the way, the four that didn’t are Citigroup (NYSE: C), SunTrust (NYSE: STI), Ally Financial and MetLife Bank (maybe they should stick to life insurance).
One bank that cut the mustard was BB&T Corp. (NYSE: BBT). This bank has a market cap of $22 billion, has nearly 1,800 branches and is located on the West Coast. After passing the test, it increased its dividend 25 percent to 20 cents per share, which would put their yield around 2.5 percent based on the current price. The stock was a low of $18.92 back in September of last year and has risen 64 percent since then.
Don’t beat yourself up about not buying the stock back then — think about where you will be over the next 12-24 months. Looking out to December 2013, the mean of 27 analysts are projecting earnings per share of $2.88. Using an earnings multiple of just 15 would put the stock price right around $43, giving investors roughly a 39 percent gain from current levels not including the 2.5 percent dividend.
Price to tangible book value is reasonable at 2.1, and the company has grown its earnings per share by 57 percent year over year. The bank also has a long-term peg ratio of only 1.26 compared to the industry average of 1.74; the S&P 500 is 4.3.
Going forward, we should continue to see more good news and less bad news. When the bad news comes in, it could make for a good buying opportunity on the right companies with the right numbers.