Best of the 'Big Four' Banks Could Be Your Ticket to Double-Digit Profits

Here's a contrarian thought: What is a negative for the overall market appears to be a positive for money center banks.

At her first news conference as central bank head, Janet Yellen stated the Federal Reserve could end its bond-buying program by this fall. She added that interest rates could begin to rise in about a year's time.

Unlike many stocks, banks typically benefit from rising interest rates since it means they can command higher lending rates on loans and mortgages.

In addition to Yellen's remarks, banking stocks were also recently buoyed by results of the Fed's largely positive annual "stress test." Released Thursday, March 20, 29 of the 30 banks appeared solid enough to weather a major financial storm. Only Zions Bancorp (NASDAQ: ZION) failed to show it has sufficient capital to handle a potential economic crisis.

The Fed is scheduled to release its Comprehensive Capital Analysis and Review on March 26. That will allow it to give approval for the major banks to increase dividends and/or buy back shares. Possible dividend hikes, combined with share buybacks and the impact of higher rates on earnings, make banking stocks seem like an attractive bet at this time.

Of the "Big Four" U.S. banks, my favorite is Bank of America (NYSE: BAC)

My first rationale is earnings growth. Bank of America has an impressive full-year 2014 earnings outlook. Analysts project earnings per share (EPS) will surge 47% to $1.32 from $0.90 last year. In comparison, JPMorgan Chase's (NYSE: JPM) earnings are expected to rise 36% to $5.90 per share from $4.35 last year. 

The laggards of the Big Four are Citigroup's (NYSE: C), with 2014 EPS estimated to increase less than 10%, and Wells Fargo (NYSE: WFC) with just 4%.

Second, Bank of America is largely insulated from overseas markets. As the Fed starts to taper, emerging markets could feel the effects. However, Bank of America will likely be stable since about 90% of its revenues are generated domestically. In contrast, JPMorgan and Citigroup derive about half their revenue from overseas.

Third, technical analysis shows Bank of America's chart is the most bullish of the Big Four. The company has handily outperformed its peers and is trading at a multiyear high. 

As the two-year chart below shows, BAC has gained about 165% since its May 2012 low of $6.67. 

BAC Sock Chart

A secondary bottom of $6.86 formed a few months later in July 2012, which is the starting point for drawing a major uptrend line. From this secondary bottom, shares rose steadily until July 2013, when they approached round number resistance near $15. 

Between July and early November, BAC consolidated in a narrow range between about $13.50 and $15. In early November, shares bullishly penetrated $15, and this level now marks a strong shelf of lateral support.

BAC resumed its advance in December, hitting a peak above $17 in early January, and then consolidating. In late February, shares challenged support near $16, marked by the intersection of the major uptrend line. 

Not only did support hold, but the stock hit a fresh multiyear high above $18. Shares are currently trading just above the major uptrend line.

Analysts following the company believe the stock could go as high as $21. In all probability, shares will test round number resistance at $20, which is why my target is just below at $19.95. At current levels, this target presents traders with 13% potential returns. With the major uptrend line providing a clear stop loss at $16.75, at which level a trendline break would occur, the trade's reward to risk is roughly 2:1. 

The fundamentals are also sold. Although 2014 revenues are projected to only inch up 1% to $89.8 billion, the earnings outlook is much brighter. With credit losses expected to be near historic lows and cost-saving initiatives in place, analysts expect full-year 2014 earnings will increase 47% to $1.32 per share. As stated above, this is the best percentage-wise of the Big Four banks.

In addition to a strong technical and fundamental outlook, BAC is attractively valued with a forward price-to-earnings (P/E) ratio of only 11 and an expected five-year PEG (price-to-earnings divided by growth) ratio of 0.53. A PEG of 1 is considered to be fair value.

The company also rewards shareholders with a small $0.04 dividend for a forward annual dividend yield of 0.2%. However, a Rafferty Capital Markets analyst believes the bank will likely increase its annual dividend fivefold, to $0.20 per share, provided it receives regulatory approval to do so. The dividend hike could come any time after Wednesday's Comprehensive Capital Analysis and Review results, making this an opportune time for entry.

Risks to consider: Banking stocks are at the heart of the economy. If the economy slows, so too will bank profits. However, with the Fed set to reduce its bond buybacks, their reading on the economy appears to be that it is accelerating not slowing. 

Recommended Trade Setup:

-- Buy BAC at the market price
-- Set stop-loss at $16.75, just below current support marked by the intersection of the major uptrend line
-- Set initial price target at $19.95 for a potential 13% gain by mid-2014

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