Best Bank Stocks to Watch in 2022
Banks appear to be complicated businesses, and in many ways, they are. Banks and other financial institutes make their money through simple concepts that can be understood by anyone. Keeping that in mind, here are some great beginner-friendly bank stocks to keep an eye out for. Here are some important metrics investors should know about banks, a quick look at some bank stocks, and three great beginner-friendly bank stocks to keep an eye out for.
Three categories of banking businesses
- Commercial Banks: Commercial Banks are banks that offer services to consumers and businesses, including checking and savings accounts, auto loans, mortgages, certificates of deposit, and more. The major way a commercial bank makes money is by borrowing money at a relatively low-interest rate and then lending it to customers at a higher interest rate. The majority of the money earned by commercial banks comes from interest income, but they also collect substantial fees from things like loan origination fees, ATM surcharges, and account maintenance fees. Investors should be aware that commercial banking is a cyclical industry — when recessions hit (and pandemics strike), unemployment rises, and consumers and businesses often have trouble paying their bills.
- Investment Banks: Investment banks offer investment services to institutional clients and high-net-worth individuals. In addition to helping companies go public through IPOs, advising on mergers and acquisitions, and issuing debt securities, investment banks earn fees from these activities. Investment banks also make money from trading equities, fixed-income securities, currencies, and commodities. In addition to wealth management businesses, they usually have substantial investment portfolios of their own. Unlike commercial banking, investment banking does very well during recessions. In fact, when markets get volatile, investment banking generally does better.
- Universal Banks: Banks with both commercial and investment banking operations are universal banks. The majority of large U.S. banks are universal banks. Commercial banks earn the majority of their profits from interest income, while investment banks make their money primarily from fees. Universal banks, on the other hand, earn both interest income and fee income.
These are clearly simplified definitions. There are other ways for banks to generate revenue. Some banks make money by partnering with third parties to lease safe deposit boxes to their customers. However, at their core, these are the main ways that banks make their money.
In 2021, you should keep an eye on these three top bank stocks
On the major U.S. exchanges, hundreds of banks trade, and they come in a variety of sizes, locations, and focus areas. While there are many excellent choices in the investable universe, here are three beginner-friendly bank stocks that could deliver excellent returns for years to come:
Bank of America
Even as interest rates fell, Bank of America was able to turn around its troubled profitability, becoming one of the most impressive turnaround stories of the post-financial crisis era. Over the last few years, the bank has increased its loan portfolio at rates that are far above those of its peers, and the company has improved efficiency while building out its online and mobile technology. In addition to its excellent asset quality, Bank of America has a relatively high concentration of non-paying deposit accounts. This puts the bank in a good position if and when interest rates rise.
In addition to being the most profitable bank among the big universal banks, JPMorgan Chase is the largest bank by market capitalization in the U.S. JPMorgan Chase operates in nearly all areas of commercial and investment banking, and the bank has made great strides in expanding its credit card and auto loan businesses in recent years. Similarly, JPMorgan Chase has invested in a number of financial technology, or fintech, companies, doing a fantastic job of embracing new technologies.
US Bancorp is primarily a commercial bank, with almost all of its revenue derived from loans and other consumer banking products. Besides U.S. Bancorp (known to most Americans as U.S. Bank) being focused on consumer banking, it consistently produces some of the most impressive profitability and efficiency metrics in the sector and has been an excellent dividend stock. Due to its absence of investment banking, which tends to be more volatile within the banking industry, US Bancorp’s profitability and revenue are more predictable and consistent than those of the other two banks on this list.
Metrics to consider for investors in bank stocks
Here are some metrics you may want to add to your toolbox if you’re looking to invest in individual bank stocks:
- Price-to-book (P/B) value: Another excellent valuation metric for bank stocks, the price-to-book ratio measures how much a bank’s assets are worth in relation to the stock’s price. These metrics can be used in conjunction with the profitability metrics discussed next to get an overall picture of how cheap or expensive a bank stock is.
- Return on equity(ROI): Several profitability metrics are used to measure the profitability of bank stocks, but one of the most commonly used is return on equity (ROE), which is a percentage of a bank’s shareholders’ equity. Higher is better; 10% or above is generally considered sufficient.
- Return on assets (ROA): This is a bank’s profit as a percentage of the assets on its balance sheet. In the case of a bank making $1 billion profit and having $100 billion in assets, its return on assets would be 1%. A return on assets of 1% or greater is generally desired by investors.
- Efficiency ratio: A bank’s efficiency ratio is a percentage that tells investors how much the bank spent to generate its revenue. Using the 60% efficiency ratio as an example, the bank spends $60 for every $100 in revenue. The efficiency ratio is calculated by dividing noninterest expenses (operating costs) by net revenue, and the lower the number, the better.
The cyclical nature of bank stocks
The bank sector can be a great place to invest, especially in strong economies. Profits generally increase and loan defaults are kept under control when consumers are confident and unemployment is low. Banks, on the other hand, tend to perform poorly during recessions and other uncertain times. In investing terms, this means banks are cyclical.
In recessions and other tough economic times, banks tend to perform poorly for several reasons. They may have to deal with a wave of loan defaults if unemployment rises. Additionally, during recessions consumers tend to put the brakes on spending, resulting in lower loan demand. Furthermore, interest rates tend to decline during tough times, which is bad news for banks’ profit margins.
Additionally, some parts of investment banking — specifically trading and underwriting — tend to do better in turbulent times. Goldman Sachs (NYSE:GS) and JPMorgan Chase (NYSE:JPM) which have large investment banking operations may be helped by this, while banks focused primarily on commercial banking, such as Wells Fargo (NYSE:WFC), may be at a temporary disadvantage.
Warren Buffett is a fan of banks
Warren Buffett is one of the greatest stock investors of all time, with Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) CEO Berkshire Hathaway. Buffett has delivered annual returns more than double those of the S&P 500 over the course of his 55 years at the helm of Berkshire Hathaway, and he has done so through the investments he has chosen for Berkshire’s massive stock portfolio over the years.
Take a look at Berkshire’s stock portfolio, and you’ll find one major trend — Buffett owns quite a few bank stocks. The company owns stakes worth $1 billion or more in four different bank stocks, including a substantial stake in Bank of America.
Here is the bottom line for bank stocks
Even though it’s not a good idea to invest in any stock just because it’s owned by a billionaire (even Warren Buffett), there does appear to be some value in the banking industry in 2021. Consequently, if you don’t have much exposure, one or more of these rock-solid banks may be able to help you build your portfolio.