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Stocks to bank on

Offering yields as high as 4.8% and the chance for capital gains, banks are key choices for conservative investors.

By Michael Sivy, Money Magazine editor-at-large

NEW YORK (Money) -- All five of the big banks in the Sivy 70 have reported quarterly results in the past 10 days, and the results for the most recent quarter have been remarkably varied.

J.P. Morgan Chase turned in a 66 percent increase in earnings per share, while profits at Citigroup fell 25 percent.

But while the companies' earnings results have differed greatly, shares in all but Washington Mutual have outperformed the S&P 500 over the past year with gains ranging from 16 percent to 30 percent. Moreover, they all yield more than the S&P 500, with payouts from 2.8 percent to 4.8 percent.

On balance, the financials were one of the most successful sectors for conservative portfolios last year. And they are likely to continue to deliver for investors seeking growth and current income.

Inflation is up only 2.5 percent over the past year. And interest rates are expected to stay flat or come down over the next few quarters. Both those developments would help bank profits.

The big banks may all have provided superior returns in 2006, but they are not all identical. Financial services include several very different businesses, and it's particularly important to distinguish among three of them.

Investment banking is booming, thanks to a robust stock market and mergers and acquisition activity. General corporate lending is also doing well.

Credit-card lending is growing but other parts of retail banking are only so-so, because consumers' spirits have been discouraged by the mild economic slowdown and the slump in home values.

Mortgage lending is the most vulnerable area, because of the weak housing market. Some adjustable loans could squeeze recent homebuyers, and defaults could rise on lower-quality subprime loans.

The prospects for any particular bank depend on its specific mix of businesses. But to some extent, share prices already reflect expectations. The biggest gains will likely be on banks that are under-appreciated or that turn in positive surprises.

Here's a quick look at the five banks that have reported recently.

J.P. Morgan Chase

Earnings per share gain in most recent quarter: 66 percent

Share price gain over past year: 30 percent

With strong investment banking growth, J.P. Morgan (Charts) has been the biggest winner. But the bank's retail business is much weaker.

The company's recent mergers have paid off well and the bank wants to make further acquisitions. But while future developments may be positive, it's hard to see that they will be a surprise.

And the shares offer the lowest yield in the group.

Bank of America

Earnings per share gain in most recent quarter: 32 percent

Share price gain over past year: 22 percent

Bank of America (Charts), which I recommended in the most recent issue of Money Magazine, has great potential for positive surprises, in my view. Earnings for the most recent quarter beat expectations, especially since analysts have been somewhat negative on the stock.

And despite above-average gains last year, the shares still look cheap, with a yield of 4.2 percent and a price/earnings multiple of less than 11 times this year's estimated results.

After buying MBNA last year, Bank of America announced the purchase of U.S. Trust from Charles Schwab. That deal should close later this year.

MBNA is already paying off, boosting earnings from credit-card lending. And as the acquisitions are fully integrated, Bank of America's profit growth could accelerate.

Washington Mutual

Earnings per share gain in most recent quarter: 29 percent

Share price gain over past year: 7 percent

Although the share price has recovered somewhat, Washington Mutual (Charts) is the only bank in the group that lagged the S&P 500 last year. The reason: This mortgage lender remains depressed because of the weak housing market.

One sign of its low valuation: The stock offers a whopping 4.8 percent yield, the highest payout in the group. But the bank's heavy exposure to mortgage lending and subprime loans leaves it vulnerable.

This is a contrarian pick that everyone has long recognized - the best time to buy it was when it hit rock bottom six years ago. Now it's not so much an overlooked value as just an under performing stock.

Well Fargo

Earnings per share gain in most recent quarter: 12 percent

Share price gain over past year: 16 percent

Despite only moderate earnings growth, this banks gets praise from analysts for the high quality of its management. The business mix is healthy and the balance sheet is solid and improving.

In addition, Wells Fargo (Charts) is the smallest of the five banking giants. That means the company has an easier time finding attractive opportunities for long-term expansion than its rivals do.

At 13 times earnings for such a solid stock, Wells Fargo could be the sleeper in the group.


Earnings per share gain in most recent quarter: down 25 percent

Share price gain over past year: 19 percent

The financial conglomerate is doing better than its earnings report suggests. But even though the share price has outpaced the broad market, Citigroup (Charts) is still a subpar performer among the banks.

The company is big and unwieldy, and it has not been able to prevent expenses from rising faster than revenues. The search for a new CFO who can tighten cost controls is under way, but recent lackluster results may reflect deeper structural and institutional problems. It's too soon to predict an improvement in results.

The bottom line: Investors looking for a solid stock in the financial sector should consider Wells Fargo. Those interested in a value investment with a high yield should take a look at Bank of America.


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