Take a Closer Look at Regional Banks

 | Nov 29, 2012 | 5:30 PM EST
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If you are looking for an industry to bank on for an investment, a good place to start is, well, the banking industry. Certainly, the industry is not as robust as it was prior to 2008's financial meltdown, but in some ways it is stronger. Regulations such as more stringent capital requirements have forced banks to be financially stronger. At the same time, experience has taught them the value of being financially more conservative.

An analyst at Wells Fargo writes, "We are moderately optimistic on the banking industry in 2013, mostly because of the emerging housing market recovery and bank stock valuations."

Certainly, banks face threats, including low interest rates, the so-called fiscal cliff facing the federal government with its spending cuts and tax increases, and the prospect for a prolonged European recession that affects our economy. But the strengthening of the U.S. economy and the strengthening of the banks themselves suggest that investors with the nerves to assume risk could be well served by investing in banks today.

For years, I have relied on a number of strategies to choose stocks to recommend. The foundations for these strategies are the writings of well-known Wall Street gurus, such as Benjamin Graham, James P. O'Shaughnessy and David Dreman.

One strategy, based on the investment approach of Peter Lynch, the great mutual fund manager, gives high marks to several banks. If you are willing to take a chance on bank stocks, these Lynch-strategy recommendations deserve your attention.

First, a word about the Lynch strategy. Its most important component and the one for which it is justly famed is the P/E/G ratio, which is the price-to-earnings ratio relative to growth. This ratio indicates how much the investor pays for growth. A P/E/G of 1.0 or less is acceptable, which is where the investor pays $1 or less for every percentage point of growth. Even better is a P/E/G of 0.50 or less, and all the recommendations I am making today fit into this latter category. Another variable used by this strategy, especially when analyzing the health of financial companies, is the equity-to-assets ratio, which has a 5% minimum. A third important variable is return on assets, which is a measurement of profitability. This must be at least 1%.

Here are three bank stocks favored by the Lynch strategy:

Bank of the Ozarks (OZRK): Founded in 1903 and based in Little Rock, Ark., Bank of the Ozarks operates more than 100 branches in Arkansas, Texas, Georgia, North Carolina, South Carolina, Alabama and Florida. Bank of the Ozarks has a P/E/G of 0.45, an equity-to-assets ratio of 12% and return on assets of 1.91%.

Park National (PRK): Headquartered in Newark, Ohio, Park National operates 11 community bank divisions and two specialty finance companies. Its primary area of operation is Ohio, though it does have operations as far afield as Florida and Alabama. Park National has a P/E/G of 0.43, an equity-to-assets ratio of 10.0% and return on assets of 1.05%.

New York Community Bancorp (NYCB): With $44 billion in assets, this is not a small bank. In fact, it calls itself "among the largest thrifts in the nation." Its primary market is the New York City metropolitan area, though it does also operate in Ohio, Florida and Arizona. It has a P/E/G of 0.44, an equity-to-assets ratio of 13% and return on asset of 1.15%.

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