I am convinced that financial companies are the place to be when an economy starts growing again. Delinquency rates fall and banks can expand their balance sheet with a much better risk profile. As a result, net profits soar. This is especially true in the US where the 2009 crisis crippled the sector for over four years and, hence, the upside potential is the greatest. Here, I present one three-stock portfolio of US financial companies, including the percentage of funds I would allocate to each stock. It is the best risk/reward adjusted equity portfolio I could find at current market prices.
The U.S. bank portfolio
Citigroup Inc (NYSE:C) trades cheaply at just 0.9 times tangible book and 10.5 times 2013 earnings. I would go long Citi, taking into account the positive outlook that will be faced by most of the bank’s business branches.
While Citigroup Inc (NYSE:C) is still digesting the drag from Citi Holdings (which generated a loss of $0.26 per share in the last quarter), this “bad asset portfolio” is being wound down fast. In just a quarter, assets decreased from $156 billion to just $149 billion. Most importantly, the bank is seeing a tremendous improvement in credit quality. Net charge-offs have come down 13 quarters in a row and non-performing assets for 11 of the last 12.
By next year, I expect Citigroup Inc (NYSE:C) to be in an unimpeachable position in terms of capital and asset quality. As a result, I would expect authorities to permit the bank a share repurchase and an increase in its dividend (currently Citi pays a 0.08% cash yield).
Since its my favorite US banking stock, I would assign Citigroup Inc (NYSE:C) a 45% portfolio weight.
Discover Financial Services (NYSE:DFS) is a direct banking and payment services company that operates two banking subsidiaries: Discover Bank and Bank of New Castle. The company’s financial results and prospects could not be better.
As a matter of fact, Discover reported 1Q’13 EPS of $1.33, beating the consensus of $1.12. More importantly, each major area of the P&L largely surpassed expectations: Discover Financial Services (NYSE:DFS) reported better revenue, lower expenses, and lower provisions.
The company is not only doing great, but is also behaving accordingly with its shareholders. During 1Q’13, Discover repurchased 6 million shares for $238 million and increased its quarterly dividend 43% to $0.20 per share, making for a 17% payout ratio. Discover’s board has also approved a two-year share buyback plan, to the tune of $2.4 billion.