Do you want to beat the market?
A version of this article originally appeared on our US site, Fool.com.
WASHINGTON, DC -- If you want to earn anything above the market return, you ought to be looking at industries and companies that are either underfollowed or reviled. If there is one area from which people can't flee fast enough, it's the European banking sector. Britain hasn't been safe, either -- with Barclays (LSE: BARC) falling again after a very brief respite, and Lloyds Banking Group shares (LSE: LLOY) showing little change in over six months. The eurozone sovereign debt crisis is like a toxic cloud hanging over the continent and financial institutions are (rightly) seen as the first potential victims. I can't think of a better place to begin looking for stock ideas.
Three criteria for success
In this type of contrarian investing, your job is to buy the baby, not the bathwater. In order to do that, you want to home in on stocks where the "headline exposure" may exceed the business risk. In this situation, I'd begin by looking at European banks that are:
- Headquartered in non-eurozone countries.
- Well capitalised.
- Cheap.
Here are five banks, four Swedish and one Swiss, that fit the bill:
| Bank | Dividend yield* | Price/TTM eps* | Core tier 1 capital ratio |
|---|
| Banque Cantonale Vaudoise | 6.4% | 14.4 | 16.8% |
| Nordea | 4.4% | 9.5 | 9.4% |
| Skandinavska Enskilda Banken | 4.4% | 7.9 | 13.0% |
| Svenska Handelsbanken | 4.8% | 10.6 | 19.1% |
| Swedbank | 5.2% | 11.6 | 17.4% |
*Based on closing prices Wednesday, 6 June. Source: S&P Capital IQ.
Let me make some general points that apply to all five of these institutions:
- Income: The shares pay a healthy dividend.
- Balance sheet: They are solidly capitalised. For reference, JPMorgan (NYSE: JPM.US), which is considered to be one of the strongest global banks, is actually a laggard relative to this group with regard to its core tier 1 capital ratio (10.4%) -- by a wide margin, in some cases.
- Valuation: The shares are cheap on the basis of earnings multiples.
Sweden's "big four"
The last four of these banks form an oligopoly in the Swedish banking industry. The Swedish Bankers' Association refers to them simply as the "big four", and they represent roughly 70% of deposits in Sweden.
Sweden suffered a severe banking crisis in the early 1990s, and with memories fresh, it is probably no coincidence that its banks suffered relatively mildly from the global financial crisis. The industry remained solidly profitable despite substantial loan losses in 2009 and 2010.
Sweden's banking system is an island of stability in a sea of uncertainty, as is its broader economy; or, as John Dizard wrote in an article published on the Financial Times website on Sunday:
"Even so, the prospective fragmenting of the euro into differently valued national euros will be a more visible risk to the world's money managers. Why not, then, put some of those balances into a country and currency that has a low, and falling, debt to GDP, a current account surplus, well-tested bank resolution and deposit protection schemes and stable, consensus politics?
"In short, Sweden, its krona, its bonds and its stocks."
Note, however, that some of the banks have substantial activities outside of Sweden, including Germany and the Baltic states.
Banque Cantonale Vaudoise
Banque Cantonale Vaudoise has seen one or two international banking crises since it was founded in 1845. The bank's name does not simply designate the bank's geographical origin -- the canton of Vaud remains its majority shareholder with just above two-thirds of the share capital (Switzerland is a federal entity, divided into "cantons").
Normally, I would view a state shareholding -- particularly a majority one -- in a private enterprise with some suspicion. That goes double for lending institutions; among the worst disasters in the Spanish banking crisis are the cajas, unlisted savings banks that were often controlled by regional politicians, which lent recklessly to finance home purchases and property development. However, Switzerland has a well-deserved reputation for conservatism and public integrity, as well as a long banking tradition.
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