Analysts and investors still say bank stocks are undervalued, even though share prices of big banks zoomed up an average 26% in the first four months of this year and command all-time-high trading premiums.
Money managers and Wall Street are predicting that improved earnings and asset quality will carry the bull market in bank stocks for another 12 months. They expect share prices to rise 15% to 20%.
"I think these stocks are going up," said Michael H. Sherman, chief investment strategist at Shearson Lehman Brothers, a unit of American Express.
Mr. Sherman recommends that bank stocks make up 16% of a portfolio, or four times the sector's representation in the Standard & Poor's 500 index.
Using 1992 and 1993 earnings estimates, Salomon Brothers Inc. calculates that the average price-to-earnings multiple of the 50 biggest banks is 30% lower than that of the S&P 500.
And while the price of bank shares soared this year, the S&P 500 was flat. That leaves room for higher bank stock valuations.
Last week, George Salem, an analyst with Prudential Securities Inc., discarded his bearish hide for bull's horns. He expects a 20% gain in bank share prices over the next 12 months.
Mr. Salem recommends the purchase of nine stocks in his 20-bank universe, his most optimistic stance since 1989.
Of course, some observers believe bank shares are overvalued. James McCormick, president of First Manhattan Consulting Group, points out that more than 35% of bank stocks now trade at least 1.5 times their book value. He said earnings do not justify that high a premium for so many banks.
The market's overvaluing, Mr. McCormick said, encouraged banks with already solid capital ratios to raise additional equity through public stock offerings without acquisitions or other strategic uses in mind. Now, with more equity, those banks must scramble to generate higher revenues.
Still, investors say the high multiple of market to book value does not dampen enthusiasm.
"Banks have the highest market to book they've ever had, but that doesn't alarm me," said James K. Schmidt, who runs the high-performing Freedom Regional Bank Fund for Freedom Capital Management Corp. in Boston. "Bank stocks are not out of line to the S&P 500."
The high premium translates into a high market capitalization for the industry overall. Managers of large funds typically invest only in corporations with big market values.
The latest bank stock rally has a different flavor than last year's. In 1991, bank stocks rose in part on investors' belief that the share prices could not go any lower.
Now, investors are drawing hope from strong first-quarter earnings and the prospect that banks will need to commit less money to fighting bad loans.
Bank stocks had a strong January and February, as investors placed bets that shares would rise with an economic recovery.
The optimism wore thin in March but was back the next month after quarterly results were posted. At present, investors generally believe the industry represents a good investment.
"I see some built-in, pretty much guaranteed earnings gains over the next couple of years," said Harry Keefe, chairman of Keefe Managers Inc., an investment fund specializing in banks and thrifts.
The rosy scenario runs like this: Nonperforming assets will decline this year. By yearend, banks' loan-loss reserves will exceed their likely losses, which means earnings and equity will not have to be sacrified to cover bad loans.
Net interest margins will stay wide, according to some optimists. Bank executives have placed more emphasis on controlling expenses. Those two factors will cancel out the lack of new revenue from lending
A Rising Tide
So earnings will rise, along with capital ratios and liquidity, which comes from investing in U.S. Treasury bills and other securities. Dividends will be restored.
"If you look out to 1993, assuming we have a moderate economic recovery, we will have a whole host of banks with the highest capital ratios since the 1950s, the most liquidity since the 1950s, and the most revenues since the 1950s," said Mr. Sherman.
Even short-sellers, who bet that stock prices will decline in the future, have backed off.
They are focusing on some of the West Coast banks and thrifts such as Glenfed Inc. and CalFed Inc. that are in danger of insolvency.
"Short-sellers got hurt last year from the banks," said Harry Strunk, an investment management consultant in Palm Beach, Fla., who tracks 24 funds that invest in short positions. "Most of them have lightened up considerably on their bank positions. They've learned their lesson. If the Federal Reserve wants to lower interest rates to help banks' profitability, it can do it."