Financial Services

A little investor fortitude may go a long, long way

Seems unlikely that there would be many buys among financial stocks, given recent scandals involving brokerages and the miserable business climate for investment banks. The Standard & Poor's 500 Diversified Financial Index, which includes a range of banks, brokerages, and finance companies, has fallen 17% in the last 12 months.

But investors with iron nerves can still find potential long-term winners among the most downtrodden of the banks and brokers--as well as some more immediate gratification from regional banks that don't have much exposure to Wall Street's woes. Some financials now look dirt-cheap. Thomson First Call expects their earnings to rise 30% this year, lead by a doubling of insurers' earnings.

The top pick of many money managers is Prudential Financial (PRU ). The property-casualty insurer and brokerage firm's stock has gained about 23% since it went public in December, 2001. Even so, Prudential's current $20 billion market value is just over its book value. Also, the company could soon join the Standard & Poor's 500-stock index, following MetLife (MET ) and John Hancock Financial Services, which were each added to the index less than 12 months after they went public. Anton Schutz, portfolio manager of the Burnham Financial Services fund, notes that soon after a stock is named to the S&P index, it typically jumps 5%, as index funds scramble to add it to their portfolios. Schutz also expects Prudential to buy back stock, because it has "way too much" capital.

The riskiest bets are brokerages. The bear market and New York State Attorney General Eliot Spitzer's campaign against equity analysts who issued overly rosy research to win banking deals erased billions of dollars from their market values. Merrill Lynch (MER ), though it was Spitzer's first target, is a favorite pick of analysts. The stock is down 25% since the start of the year, and could go lower if the company loses costly class actions. But it remains one of Wall Street's strongest brokers and could rebound once the market turns up. "If the economy recovers, the brokerage sector is where you can make more money," Schutz says.

FleetBoston Financial (FBF ), too, has been in the doldrums since recording a $500 million loss in the fourth quarter because of venture-capital write-downs and Argentina exposure. On June 6, Fitch, the rating agency, downgraded its credit outlook from stable to negative. Even so, some wonder if the bank's stock isn't finally worth betting on. Michael Mayo, Prudential Securities' notoriously bearish bank analyst, recently upgraded it to a sell from a hold. He says the company's strategy of selling its investment-banking unit and concentrating on safer havens such as retail banking and small-business lending makes sense. Still, Fleet will be no bargain if it records more losses from Argentina.

For those with less stomach for risk, there are midcap banks that focus on local businesses and have little overseas exposure. Michael Corasaniti, director of research at broker Keefe, Bruyette & Woods, recommends Compass Bancshares (CBSS ), a Birmingham (Ala.) bank with $23 billion in assets. What's so special about Compass? Nothing, says Corasaniti--and that's the way he likes it. "It's really basic, boring banking," he says. "That's the best theme for the rest of the year--keep it boring and simple."

Financial companies are at the heart of the crisis of confidence in Corporate America and the markets. And that's not going to go away quickly. But for those willing to take big risks on beaten-down stocks, there could be a payoff.

By Heather Timmons

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