Bank stocks: Buyer beware

Bank stocks are cheap, but beware - some may fall further.

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NEW YORK (CNNMoney.com) -- It's undeniable: Bank stocks are cheap.

Earlier this week, Citigroup (Charts, Fortune 500) stock finished below $30 a share for the first time in over five years. Shares of another troubled Wall Street firm, Merrill Lynch (Charts, Fortune 500), are trading at a 39 percent discount from where they were before the credit crisis erupted a few months ago. And shares of Washington Mutual (Charts, Fortune 500), the nation's largest thrift, are down more than 60 percent since the start of the year.

"There is great temptation looking at some of these prices," said Frank Barkocy, director of research at Mendon Capital Advisors in New York.

As attractive as many financial stocks appear to be, many are likely to fall further. "There is a great deal of uncertainty," added Barkocy. "We don't know where we will see the bottom."

Still, analysts argue that there are plenty of opportunities out there. Some regional banks are attractive because they have sidestepped the credit crunch. And investors in big game like Citi and Merrill could see generous returns if they stick it out for the long haul.

For now, financial stocks remain challenged. Wall Street firms, for example, face the possibility of further writedowns or a surprise development in the credit market crisis.

Lenders with a bigger exposure to mortgages, like Washington Mutual and Wells Fargo (Charts, Fortune 500), face deteriorating home prices and the threat of rising home owner defaults, particularly if the economy slips into a recession in 2008.

And, of course, it's likely that many banks will soon see earnings fall sharply in the fourth quarter, said Jaime Peters, an equity analyst at Morningstar.

"There's every single sign they're not going to look good," said Peters.

But dismal as the outlook may be, many of these banks are worth investing in.

Shares of regional outfits like BB&T (Charts, Fortune 500) and Regions Financial Corp. (Charts, Fortune 500) are significantly discounted from where they were at the start of the year. But they offer an attractive dividend yield and have largely insulated themselves from some of the problems affecting the big Wall Street banks.

"These companies don't have subprime loans, credit derivatives or structured investment vehicles," said Punk Ziegel's Dick Bove, a famously skeptical analyst who upgraded a number of banks earlier this week based on valuation. "You are not going to see big loan losses going forward."

Other regionals like the Texas-based Sterling Bank (Charts) and Cullen/Frost (Charts) are also attractive because the Texas housing market has held up despite the national housing meltdown, said Morningstar's Peters.

And even though some of the trust banks like Northern Trust (Charts, Fortune 500) or Bank of New York Mellon (Charts, Fortune 500) are trading at a premium right now, they still look fundamentally attractive, said Mendon Capital's Barkocy.

And what about the big boys like Citigroup, Merrill or one of their competitors? That depends on the bank.

A host of stocks - including Wachovia (Charts, Fortune 500) and Bear Stearns (Charts, Fortune 500) - look like bargains compared to competitors when measured on price-to-book value, a gauge of assets minus liabilities that analysts like to use as a preferred yardstick for comparing financial stocks.

But if you have a long-term investment horizon, just about any financial firm is worth snapping up.

"These stocks are cheap right now," said Peters. "We're not promising they won't continue to go down but we are saying if you buy now and hold three to five years, you will have an excellent return."