Saturday, July 19, 2008

The Case for Buying (or Selling) Financial Stocks

Thanks to this week's rally in financial shares, we're getting a barrage of media telling us to buy these oversold names. I'll take a look at both sides of the trade here.

First, on the buy side, they are simply extremely oversold. These stocks have declined steadily since basically last August, with no prolonged support or bottom.

Second, most are sporting a pretty strong dividend yield (if they haven't yet cut it). Wachovia 11.2%, Bank of America 9.7%, and Citigroup 7.1%. Wells Fargo shocked the market by raising their dividend this week. This was a move that was probably planned to help shore up confidence, because I'm sure they needed that money somewhere.

Third, most of these companies have great brand names with an amazing global reach. Especially some of the investment banks like Goldman, Morgan Stanley, etc.

Fourth, many of these companies have the most talented management in the world. Wells Fargo, American Express, Goldman Sachs, Merrill Lynch. Brand name and strong management are some of Warren Buffetts strongest criteria for picking a stock.

Now, lets look at the reasons not to buy these stocks.

First, their businesses are in disarray. The nationwide housing trouble, mixed with credit problems, have nailed these companies, many to the point of collapse.

Second, there has been no evidence that housing has bottomed. The consumer is still being pinched from all angles with energy and food inflation, while their biggest asset (their house) has lost value.

Third, and this is the biggest reason for me, is these banks are giving up their competitive advantage. They are selling stakes to overseas sovereign wealth funds. They are selling off their best assets (Merrill just sold their Bloomberg stake, and is talking about selling their Blackrock stake). Although this allows the company to stay afloat, what happens once the turmoil is over? They've lost much of what has made them great. That can make a case for never investing long term in many of these companies.

Fourth, there is no reason to believe that this weeks rally was nothing more than funds manipulating prices, or sentiment. They have a lot of money tied up in these companies, and maybe are looking for a chance to exit them, or make a short term trade.

In conclusion, I'd say you could buy financial stocks for a short term trade, if that's your style. But long term, I only like a few of these names. And that's those with strong management, who haven't leveraged their future to stay afloat now. Even once we return to normal times for these stocks, their earnings will be eroded for a long, long time.

Disclosure: None. Image borrowed from Barrons.

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