Top Analyst Says Big Upside Left in Banks: 4 to Buy for 2018

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If any sector has been on a roll since last year’s presidential election, it’s the banking and financial arena. The basic improvement in overall confidence and the hopes for less of the staggering rules and regulations that often stifle the industry have had investors bidding many of the top companies in the sector higher. One thing is for sure, while there could be big upside, stocks selection will remain very important is 2018.

In a new research report from Erika Najarian, the outstanding banking analyst at Merrill Lynch, she makes the case that given the prospects for tax and regulation reform in the coming year, there is as much as 30% upside still left in the group. She also feels that tax reform can add 1.3% to return on equities and an additional 2.0% to 2.5% with regulatory reform.

Two of the top new money ideas for 2018 — KeyCorp. (NYSE: KEY) and Wells Fargo & Co. (NYSE: WFC) — are sector laggards from this year. We also profile two additional Buy-rated companies that look like solid plays for growth investors.

KeyCorp

This is a midcap bank that makes good sense for 2018. KeyCorp operates as the bank holding company for KeyBank National Association, which provides deposit, lending, cash management and investment services to individuals, small and medium-sized businesses.

The company also provides a broad range of sophisticated corporate and investment banking products, such as merger and acquisition advice, public and private debt and equity, syndications and derivatives to middle market companies in selected industries throughout the United States under the KeyBanc Capital Markets banner.

Merrill Lynch likes the larger regional banks, noting that valuations look very reasonable and cost saving plans are helping to make forward estimates look very achievable. With overall credit remaining solid, earnings and loan deposit and fee growth all are positive metrics for the bank. The firm noted in a recent report:

Despite solid execution on standalone and deal-related goals, the company still trades at a steep 2.5x estimated 2018 earnings discount to peers. After recent meetings with management, including CEO Beth Mooney, we are more confident KeyCorp can exceed its financial targets. The company has the highest upside potential in our group.

Investors are paid a 2.17% dividend. The Merrill price target for the stock is $22, and the consensus target is $20.77. The shares were trading Thursday morning at $19.50.

Wells Fargo

This large cap bank is a solid value play for 2018. Wells Fargo is a nationwide, diversified, community-based financial services company with $1.8 trillion in assets. The company provides banking, insurance, investments, mortgage and consumer and commercial finance through 8,700 locations, 12,800 ATMs, the Internet and mobile banking. It also has offices in 36 countries to support customers who conduct business in the global economy. Wells Fargo serves one in three households in the United States.

Wells Fargo has slowly, but surely, become one of the biggest mortgage lending companies in the United States, in addition to its normal banking and brokerage businesses. A continued increase in commercial real estate lending could really boost the bank’s bottom line and overall revenue. The stock also remains a top Warren Buffett holding.

The company has massively underperformed the banking index this year. Wells Fargo posted quarterly revenue that missed the consensus estimate from analysts polled by Reuters. The bank did report slightly better-than-expected earnings per share, excluding charges related to litigation for a mortgage-related regulatory case from before the financial crisis. Net interest income rose nearly $500 million from a year earlier but missed consensus expectations posted by FactSet.

Wells Fargo still remains a show-me story, but it is possibly the cheapest of the banks for investors looking for larger upside potential.

Shareholders are paid a decent 2.66% dividend. Merrill Lynch has a $62 price target, and the consensus target is at $57.69. Shares were trading at $59.20 Thursday morning.