Banking on stock bargains

What are we looking for?

Let's try to go bargain hunting in the U.S. financial sector.

More about today's screen

The financial sector within the S&P 500 fell 23 per cent in the third quarter. Not one of the 81 members had a positive return, even including dividends.

CPMS Morningstar, an equity research shop, calculates that the median price-to-book value for the U.S. financial sector has dropped to 0.96 – a level that has only been reached on one previous occasion since 1993. That was in early 2009 during the worst of the last market panic.

Craig McGee, a senior consultant with CPMS, put together a screen for U.S. financial stocks with market caps above $1-billion. Stocks had to be trading below book value and in the past three months analysts had to have held steady or increased their earnings estimates on average for the next year.

More about CPMS

CPMS is an equity research and portfolio analysis firm owned by Morningstar Canada. It maintains a database of about 680 of the largest and more liquid Canadian stocks, plus more than 2,200 U.S. stocks, and spends a lot of time adjusting for unusual accounting items in each company's quarterly results to make sure screens can perform correctly.

What did we find out?

In the six months after February 2009, when the financial crisis was at its worst, the S&P 500 financial sector surged 97 per cent. It was a prime way to play the recovery.

The current downturn isn't rooted in the financial sector the same way the bear market of 2008-2009 was, but this screen should help investors find value if they believe we're near the bottom again.

The price-to-book ratio is generally a good value indicator since it measures what the market is paying for what would be left over for shareholders if the company were sold without any leftover debt, Mr. McGee said.

"Hopefully the last downturn forced these companies to write-off their toxic assets, leaving us with a reliable and comparable book value," he said. "To help prevent falling into a value trap, it is important to focus on companies that have improving [earnings]expectations and not just look to valuations alone."