BANK OF AMERICA: Buy these 6 financial-sector stocks that offer the most attractive risk-reward combo as the economy improves

  • Financial-sector stocks tend to be some of the most economically-sensitive in the market.
  • In a recent note, Bank of America laid out six financial stocks with the best risk-reward ratio to buy for the economic recovery.
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One of the most economically sensitive — or cyclical — stock market sectors is financials.

This is because companies in the group are impacted by factors like consumer willingness to take out lines of credit and interest rates. That means they can be great buys at the beginning of a new economic cycle, returning profits as the economy picks up. 

But they can be risky stocks to own when the economy isn't in the clear yet: hundreds of banks failed following the Global Financial Crisis. 

This year, as the economy plunged at record speed, banks have been taking measures like tightening their lending standards and setting aside billions of dollars to weather the storm. Others are shrinking their physical presence — U.S. Bancorp announced recently that it will close 400 branches in the coming months.

Now, with the economy gaining momentum, which are the best financial stocks to buy? In a recent note, Bank of America laid out which six they believe have the best risk-reward ratio. They are listed below with the bank's commentary for each.

1. BlackRock Inc.

Ticker: BLK

Commentary: "Our PO is $675, based on a PE multiple of 22x on '21E, at a premium to peers (12x), given a higher growth rate with its ETF exposure and diversification."

"Downside risks to our price objective are market/AUM declines and operational issues or tracking errors within ETFs, which could stymie the growth of iShares. Regulatory risks are possible capital requirements for money market providers or BLK's designation as a SIFI. Upside risks are market appreciation, outperformance and continued strong net inflows."

Source: Bank of America

 

2. Focus Financial Partners

Ticker: FOCS

Commentary: "Our PO is $44 which is based on a PE multiple of 14x on '21E, in line with the peer group given FOCS's superior top and bottom line growth rates, as a result of its positioning in the faster growing RIA market and acquisition opportunities, offset by a higher leverage and adjustments, limited operating leverage, and share overhang."

"Downside risks to our PO are a weaker macro environment (lower markets and fewer acquisition opportunities), rising rates (elevated debt to fund deals), increased pricing pressure on wealth management fees, increased competition for talent acquisition and new entrants in the RIA consolidation space."

"Upside risks to our PO is a stronger macro environment, faster than expected growth rates in the RIA market, and increased acquisitions."

Source: Bank of America

 

3. Goldman Sachs

Ticker: GS

Commentary: "We value the brokers based on the relationship between ROTE (return on tangible equity) and PTB (price to tangible book), which has a high historical correlation. Our PO is $240, which is based on a TBV multiple of 1x on '21E (a discount to historical levels as we factor in the weaker earnings potential from a 100% chance of a near-term recession) versus our 2021E ROTE of roughly 9%, with litigation uncertainty manageable and consumer credit risk minimal."

"Risks to the upside is a quick 1MDB resolution and stronger capital markets activity. Risks to the downside are a weaker economy/capital markets, macro or geo-political issues, competition, structural pressures, tougher global regulation, a more severe 1MDB outcome, and litigation."

Source: Bank of America

4. KKR & Co.

Ticker: KKR

Commentary: "Our price objective (PO) for KKR is $43, which results in a target price-to-DE (price to distributable earnings) multiple of 27x our 2021 DE estimate. Our price objective is based on our sum-of-the-parts (SOTP) analysis. Our SOTP analysis is based on the following base case components: a target multiple on fee related earnings (20x/$22 – a premium to asset manager multiples given higher growth, locked up capital, & upside from the Global Atlantic transaction), 1x book value for the balance sheet investments and accrued carry ($14), and 60% credit for the discounted value on the performance fee upside over a cycle (1.8x MOIC/$7), resulting in total value of $43 and a P/DE multiple of 27x."

"Downside risks to our PO: a weak macro and capital markets backdrop, regulatory and political risk, poor performance, weak fundraising, principal investment and balance sheet risk, expansion risk, key person and talent risk, competition, a unique corporate structure that limits shareholder control, and share lock-ups that could weigh on the stock."

Source: Bank of America

 

5. Nasdaq Inc.

Ticker: NDAQ

Commentary: "Our PO is $148, which is based on a PE multiple of 25x on '21E, a premium to historical levels and the sector, given NDAQ's diversified revenue mix and business model."

"Upside risks to our PO are a weak macro backdrop, reduced competition, less pricing pressure, margins, technology, operational, accretive M&A, regulatory, and legal. Downside risks to our PO are lower volume outlook, higher pricing pressure, lower non- transaction revenues, lower margins, and failure on M&A opportunities."

Source: Bank of America

 

6. State Street Corporation

Ticker: STT

Commentary: "Our PO is $70, based on a PE multiple of 12x on '21E, at a modest discount to peers given the lower revenue growth outlook and deal risk."

"Downside risks to our PO are weaker markets and FX, lower rates, outflows, lost business, lower activity levels, intense competition, and increased regulation and legal risks. Upside risks to our PO are stronger markets, rates rising faster than expected, healthy activity levels, less competition, and decreased regulation."

Source: Bank of America

 

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