Given enough time, the small caps from any industry are apt to outperform their large caps siblings. The problem is, investors tend to gravitate toward the larger and more familiar names, while the worthy, off-the-radar small caps tend to be overlooked.
The idea applies within the banking sector as well as it does anywhere else. Case in point:Wells Fargo & Co. (NYSE: WFC) versus KeyCorp (NYSE: KEY). The former is one of the nation's biggest and best-known banks, and is therefore a comfortable and common investment. The latter, though, technically a national bank and the country's 17th largest, is still relatively unknown because it behaves more like a local community bank. As such, it's often passed over, even though it may be the better bet for investors.
More than a head-to-head competition
On the basis of nothing but a fundamental snapshot, Wells Fargo may appear to have a slight edge on KeyCorp. Wells is technically cheaper in terms of a trailing price-to-earnings (P/E) ratio (14.4 compared with 19.6), as well forward P/E (8.9 compared with 11.0). Wells Fargo also boasts a stronger return on equity -- 10.4% for the past 12 months, while KeyCorp's is 5.4%. And, Wells Fargo's trailing net profit margin of 16.5% tops KeyCorp's 14.5%.
On the basis of nothing but a fundamental snapshot, Wells Fargo may appear to have a slight edge on KeyCorp. Wells is technically cheaper in terms of a trailing price-to-earnings (P/E) ratio (14.4 compared with 19.6), as well forward P/E (8.9 compared with 11.0). Wells Fargo also boasts a stronger return on equity -- 10.4% for the past 12 months, while KeyCorp's is 5.4%. And, Wells Fargo's trailing net profit margin of 16.5% tops KeyCorp's 14.5%.
In fact, there aren't a lot of valuation categories that KeyCorp wins when pitted against Wells Fargo.
So what, prey tell, makes KeyCorp so much better than its bigger brother? It's what the raw data doesn't tell you...
At the pivot
To give credit where it's due, Wells Fargo was profitable in 2009, earning $1.75 per share, and then followed that by earning $2.21 in 2010. KeyCorp, on the other hand, lost $2.34 in 2009 and barely swung back to a profit in 2010. Though it only posted income of $0.44 per share last year (well under 2006's peak income of $2.97), the turnaround story for KeyCorp is just getting started. Wells Fargo's rebound, in contrast, is mostly behind it.
To give credit where it's due, Wells Fargo was profitable in 2009, earning $1.75 per share, and then followed that by earning $2.21 in 2010. KeyCorp, on the other hand, lost $2.34 in 2009 and barely swung back to a profit in 2010. Though it only posted income of $0.44 per share last year (well under 2006's peak income of $2.97), the turnaround story for KeyCorp is just getting started. Wells Fargo's rebound, in contrast, is mostly behind it.
On the surface it may seem academic. It isn't, though. Investors like profitable companies, but they love -- and buy into -- turnaround stories.
Just to inject some numbers into the idea, Wells Fargo's bottom line is expected to grow by 28% in 2011 and by 26% in 2012. KeyCorp's income is expected to grow 56% in 2011, and then by 14% in 2012. Even with KeyCorp's expected taper in profit growth next year, it's still going to grow earnings at a faster clip for the two-year span.
There's more to KEY's upside than just budding earnings growth though. The fact is, analysts' estimates of the company's earnings growth may still be too timid.
Repeatedly underestimated
In the past seven straight quarters, KeyCorp has either shrunk its losses or grown its bottom line. In all five of the most recent quarters, KeyCorp has topped analyst estimates. Topping estimates once or twice can be chalked up to errant analyst guesses in a tricky environment. Topping estimates five straight times, however, indicates habitual pessimism and a little stubbornness from the analyst community.
Repeatedly underestimated
In the past seven straight quarters, KeyCorp has either shrunk its losses or grown its bottom line. In all five of the most recent quarters, KeyCorp has topped analyst estimates. Topping estimates once or twice can be chalked up to errant analyst guesses in a tricky environment. Topping estimates five straight times, however, indicates habitual pessimism and a little stubbornness from the analyst community.
Considering KeyCorp has beaten forecasts -- usually by a lot -- for over a year now, there's a good chance earnings may grow by a heck of a lot more than the anticipated 56% this year.
The kicker here is the tepid opinion analysts still have on the stock. Intuition says you'd want to own a highly-rated stock. History, however, indicates that analyst opinions often don't change until well after they should (and often well after a big move).
Beyond the numbers
As important as valuation, growth and opinions are, they're still not the whole story.
Beyond the numbers
As important as valuation, growth and opinions are, they're still not the whole story.
KeyCorp may actually garner a little more political goodwill soon at a point when banks need all they can get -- and it could simultaneously get a fiscal monkey off its back. The bank plans on repaying its $2.5 billion loan from TARP (Troubled Asset Relief Program) soon, with the government's proverbial blessing.
The quarterly dividend, which had been $0.01 per share since late 2009, is going to be ratcheted back up to $0.03. Consistent dividends at that pace would bring the yield back up to 1.3%, but more important, there's still the possibility of dividend growth down the road. Remember, KeyCorp was paying a slightly higher dividend right before the financial crisis struck, and the company has reliably improved its payout in the past several years leading up to the cut.
Better still, KeyCorp recently unveiled plans to expand its community banking business, where it can compete with local players in terms of customer service, yet still offer big-bank choices.
Action to Take --> To be fair, none of this is to imply Wells Fargo is a problematic stock doomed for disaster. It's a huge company though and suffers from the usual problem associated with being big... slow to move, weak customer service and an inefficient bureaucracy. Indeed, Wells may be the healthiest large-cap measuring stick with which we can compare KeyCorp. It's just that KeyCorp tops Wells Fargo with relative ease when it comes to actual growth prospects.
Action to Take --> To be fair, none of this is to imply Wells Fargo is a problematic stock doomed for disaster. It's a huge company though and suffers from the usual problem associated with being big... slow to move, weak customer service and an inefficient bureaucracy. Indeed, Wells may be the healthiest large-cap measuring stick with which we can compare KeyCorp. It's just that KeyCorp tops Wells Fargo with relative ease when it comes to actual growth prospects.
With earnings set up to grow by at least 50% this year, a 30% upside for KeyCorp shares would still leave it at just an average valuation for the sector.
No comments:
Post a Comment