3 Regional Banks to Bank On

 | Sep 02, 2016 | 2:00 PM EDT
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The tide could be turning for small banks -- including these three that my "guru screens" like.

Although the SPDR KBW Regional Banking ETF (KRE) has lagged the broader market since 2008's end, it's up 11.7% since the second quarter ended. That beats both the 7.3% gain seen by the broader Financial Select Sector SPDR ETF (XLF) , as well as the S&P 500's 4% rise since the second period ended.

KRE had previously lagged both. The ETF generated just 68.4% total returns since 2008's end vs. 123.2% for XLF and 184.2% for the S&P 500. But now, the market seems to be pricing a better, more-profitable business environment for smaller regional banks.

That's due in part to improving odds of a September or December Federal Reserve rate hike. After all, value stocks and financials are two market sectors that historically benefit the most from rising-rate environments.

The intersection of the two looms large in the regional-banking industry, which has fallen behind the broader market in recent years amid regulatory overhangs, slow growth and an ultra-low interest-rate environment. And within the banking sector itself, regional banks tend to be more interest-rate sensitive than larger institutions whose valuations are often affected by heavy merger-and-acquisition activity.

But in a recent interview with WealthTrack, Chris Davis of value-investing firm Davis Funds described what he views as both a secular and cyclical opportunity in many financial stocks. He said growth prospects for the sector as a whole look promising over the long term.

David added that discounted valuations combined with market negativity toward the group provide a cyclical opportunity for investors. When secular and cyclical opportunities align (as they did in the early 1990s after the U.S. Savings & Loan Crisis), that can mean strong returns for patient investors.

Now, regular readers know that when searching for stocks, I use a series of quantitative models based on the publicly disclosed strategies of great investors like Warren Buffett and the late Ben Graham. Here are three regional bank stocks that get high marks from these models based on their current valuations, positioning and growth characteristics:

Franklin Financial Network (FSB)
This financial-holding company has a $368 million market cap and operates Franklin Synergy Bank in and around Nashville, Tenn.

Franklin Financial scores in the 90% range on four of my models -- an unusual distinction. The shares do well on my Martin Zweig, Peter Lynch and Motley Fool simulations, as well as on my Validea Momentum screen. Positives include 20% long-term earnings growth, a 1.8 price-to-book ratio and a 12.2% return-on-equity level.

FSB also carries a 88.0 relative strength, meaning that the shares have exhibited strong price performance over the past year vs. the majority of other stocks. All told, the combination of strong price performance, reasonable valuations and solid earnings growth give the stock plenty of appeal.

Home Bancshares (HOMB)
This bank-holding company's Centennial Bank unit operates 157 branches in Arkansas, Alabama and Florida.

The company boasts solid 31.1% earnings growth based on the average of its three-, four- and five-year historical earning-per-share growth rates. HOMB also has a favorable 0.65 P/E/G ratio (short for "price to earnings to growth"). A low P/E/G is a cornerstone of my Peter Lynch-based strategy, which also likes Home Bancshares' 13% equity-to-assets ratio (a metric only applied to financial institutions).

Enterprise Financial Services (EFSC)
This firm owns Enterprise Bank & Trust, which primarily operates in the St. Louis, Kansas City and Phoenix metropolitan markets.

The $617 million firm gets high scores on three of my guru strategies. For example, my Peter Lynch model rates the stock highly due to EFSC's 25% long-term EPS growth rate, 14.3 P/E ratio and 0.57 P/E/G reading.

In addition, the "growth investor" approach that I base on Martin Zweig's strategies likes both the firm's recent profits and earnings acceleration. Rounding out this "trifecta of strategies" is my Momentum Screen, which gives the stock an 89% score based on a wide variety of fundamental and price-performance criteria.

EFSC also has a relative strength of 81, which indicates that the market has rewarded the shares recently. If growth continues, I expect investors will continue to do so.

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