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Next week, the Federal Reserve will meet for two days to discuss the state of the U.S. economy. While the labor market has shown some weakness in recent months, the Fed is expected to start planning efforts to taper its balance sheet.
The unemployment rate sits at 4.8%. However, the workforce has witnessed a large exodus of service and hospitality workers in recent months. If you visit a restaurant, grocery store, or shopping center, you’ll see a lot of “Help Wanted” signs. To attract talent, companies will need to pay higher wages, a factor that acts as its own form of inflation on products and services.
The Fed has a challenge ahead. It must consider interest rate hikes to limit inflation and taper its balance sheet to reduce the flood of money in the economy. But higher rates will naturally have a negative impact on the stock market — particularly frothy technology stocks trading at high valuations. So, where does value and opportunity exist with the S&P 500 and Nasdaq sitting at record highs?
As I explained yesterday, there is ample opportunity in the banking sector.
Higher Rates and Consolidation
Banks will benefit from higher interest rates in the future. An uptick in rates and a shift toward normalized lending conditions will allow banks to generate more revenue from their bread-and-butter lending practices.
As I noted yesterday, banks trading at a price-to-tangible-book value under 1 create interesting opportunities. Investors can take advantage of companies of all sizes in the financial industry by using this metric. The lower valuations in the community banking space are attractive because of the ongoing consolidation trend of the last 30 years. Today, let’s look at three different banks that offer unique upside in the future and carry “buy” ratings in TradeSmith Finance.
Bank No. 1: First Northwest Bancorp (FNWB)
First Northwest Bancorp is a community bank based in Port Angeles, Washington. Founded in 1923, the company owns 15 locations across western Washington state, including a lending center in Seattle. Its product lines include savings accounts, mortgages, deposits, loans, and other financial products. The company has experienced strong deposit growth over the last year, which helped propel it to a strong earnings report at the end of the second quarter of 2021. The company will be reporting earnings in the coming days, according to MarketChameleon. We anticipate that the company will provide a strong outlook based on previous forecasts of other community banks that experienced strong deposit growth.
FNWB currently trades at 0.94 price-to-tangible-book value, meaning that it’s selling at 94 cents on the dollar. With a strong balance sheet and strong deposit growth, FNWB could be a potential takeover target of a large regional or national bank that wants to grow its presence in the Seattle market, which experienced population growth of 21% from 2010 to 2020, according to U.S. Census data.
Although Wall Street tends to ignore the opportunities in community banks, an analyst at Piper Sandler initiated coverage of the company in August with a price target of $20. That figure represents an upside of about 17.5% from the current price. The stock also sits in the Green Zone on TradeSmith Finance and has experienced positive momentum over the last few months.
The average trading volume is just 15,000 shares per day, and anyone who is buying at the market will quickly drive up the price of the stock. However, just 446 shares exchanged hands on Tuesday before 1 p.m. With low volumes, investors need to be cautious to avoid overpaying for the stock.
The bid price on Tuesday was about $17, while the ask price was $17.15. Investors who are interested in owning the stock for the long term should set a limit order at $17 and wait. It may fill on Wednesday. It may fill in two weeks. But the point of this strategy is to ensure that you do not pay too much for this stock. Don’t just buy the stock at market price. I repeat, do not buy the stock at market price.
With smaller community banks, especially those trading under a price-to-tangible-book value of 1, you need to have a plan. That’s where using a buy limit order comes into play. You can set a “buy” at the bid price and set “good-til-cancelled” and just wait.
Bank No. 2: Northeast Community Bancorp (NECB)
From the great Northwest to White Plains, New York. In 1934, NorthEast Community Bank was founded as a local financial institution. Like many other companies in the sector, it provides mobile banking, loans, and other financial services. The stock has a market capitalization of roughly $178 million, according to Google Finance, and maintains a daily volume of roughly 85,000 shares. The company currently trades at a price-to-tangible-book value of 0.83. Again, that’s 83 cents on the dollar.
The company operates 14 locations across New York state and Massachusetts. NECB has a little more volume, but investors should consider similar buy order limits to ensure they can lock in the best price. It pays to be patient when investing in these smaller banks, and remember that it’s a marathon and not a sprint when playing the consolidation trend in the industry.
Bank No. 3: Citigroup (C)
You don’t need to limit your focus to the community banking space if you’re looking for value. Citigroup is a diversified financial institution with a market capitalization of $144.08 billion, according to Google Finance. This makes Citigroup the 11th-largest financial institution in the world, and the sixth-largest in the United States. Compared to its large competitors, the stock is relatively inexpensive. It currently trades at a price-to-earnings ratio of 6.67 and a price-to-tangible-book value of 0.9. While Citigroup isn’t a company that is going to be purchased in a buyout, it does present a unique upside, according to Wall Street.
The average price target for Citigroup over the next 12 months is $90.29, a figure that represents a potential upside of 26.6%.
Citigroup currently sits in the Green Zone and carries upward momentum heading into the November Fed conference.
Tomorrow, we’ll talk more about what to expect from next week’s Federal Reserve meeting.