How to Find Lucrative Financial Institution Stocks

The recent economic and stock market meltdown started with the implosion of a handful of big banks and Wall Street brokerage firms. And the financial sector continues to feel the pain. Shares of Citigroup (NYSE: C), for example, traded at more than $55 a share in mid-2007 but sell for less than $3 now. American International Group (NYSE: AIG), once considered an outstanding insurance company, has seen its stock plunge by 96% in the past 12 months.

Shell-shocked investors are fleeing financial stocks in droves. Intuitively, that means the industry is now a place to look for bargains. Surely there must be banks, brokers, and insurers who avoided the traps that snared the big players. Finding them, though, isn’t easy.

“Shifting through the data can be complicated,” says Anton Schutz, manager of Burnham Financial Industries Fund (BURFX). “Your best chance is to invest through an actively managed fund, where someone is picking stocks. If you buy a financial exchange-traded fund (ETF), which tracks an index of financial stocks, you’re buying bad companies as well as good ones.”

In general, actively managed mutual funds haven’t been as hard hit as Citigroup or AIG. Still, according to fund tracker Morningstar, specialized mutual funds lost nearly 44%, on average, in 2008. Schutz’s fund is an exception, though: it lost only 7% in 2008, followed by a gain of nearly 13% in the first half of 2009. Under Schutz’s guidance in 2008, Burnham Financial Industries Fund received the Lipper Performance Achievement Certificate for posting the best record out of 91 funds in its category.

So what is Schutz holding now? “Among the major banks, we see opportunity in Bank of America (NYSE: BAC). When things get back to normal, the company could earn as much as $4 a share. It’s trading at [more than $12] now, so the stock could double or triple in the next couple of years,” Schutz says.

Bank of America isn’t the only financial institution Schutz likes. He’s touting smaller players like People’s United Financial (NASDAQ: PBCT), which has branches throughout the Northeast, and TFS Financial Corp. (NASDAQ: TFSL), parent of Third Federal Savings and Loan Association of Cleveland. “These are among the

banks that have excess capital now,” says Schutz. “They’re buying back their own stock because the values are so compelling now. And they might be able to make acquisitions, too.”

Historically speaking, savvy investors like to buy shares in institutions that are likely to be taken over by larger firms. Given the state of the financial industry today, says Schutz, “the winners might be the buyers.” Acquirers know the industry, the logic goes, and are likely to know which companies represent good value at currently depressed prices.

The major reason for the depressed share prices in the financial sector, of course, has been weakness in real estate, which led to increasing defaults on mortgage loans. Even so, Schutz sees opportunities in the

mortgage business for one company whose shares he’s been scooping up lately: Chimera Investment Corp. (NYSE: CIM), a real estate investment trust that buys mortgages. “The company has been acquiring loans at a discount to their net asset value,” says Schutz. His overall reasoning: If it becomes apparent that the loans acquired by Chimera are relatively sound, values could move up sharply, thereby driving up the company’s stock price.

What about insurance companies? “Our top holdings include MetLife (NYSE: MET) and Travelers (NYSE: TRV), both of which have excellent financial strength,” Schutz says. Both insurers’ stocks are off sharply from last year’s highs so they could bounce back when investors are convinced the financial sector includes winners as well as losers.