Where the Money Is in Financial Services

From Standard & Poor's Equity Research

Despite talk of an inverted yield curve, volatile markets, rising interest rates, and a tumbling U.S. dollar, Standard & Poor's thinks investors in financial sector stocks can do well if they choose selectively.

Standard & Poor's current favorites in the group include Prudential (PRU; S&P investment ranking 4 STARS, buy), Goldman Sachs (GS; 5 STARS, strong buy), Citigroup (C; 5 STARS), JPMorgan Chase (JPM; 4 STARS), MetLife (MET; 5 STARS), and Bank of America (BAC; 5 STARS). From Standard & Poor's Equity Research


  All of these stocks have "low" risk-assessment scores, assigned by S&P equity analysts after taking into consideration factors like the company's corporate governance policies, litigation risk, management changes, recent competitive shifts, patent expirations, and other matters specific to the company or the industry. And, importantly, all have exposure to fast-growing emerging markets like India and China. However, it's important to note that S&P doesn't share the same outlook on all emerging market nations.

"We advise purchase of certain U.S.-based institutions based on our view of their superior total return potential and low-risk profile. We are encouraged by their valuations, steady growth prospects, geographic diversification, and developing-economy exposure," says Cathy Seifert, co-head of financial services equity research at S&P.

For instance, despite quarterly volatility, Goldman is benefiting from improving global equity markets, a pick-up in merger and acquisition activity, and higher merchant banking gains, according to Robert Hansen, co-head of financial services equity research. He says he is bullish on Goldman in part because he also expects the firm to experience strong international growth, particularly through the company's joint venture in China.


  Beijing has been steadily opening its banking sector to foreign control. So are governments of other emerging markets. Citigroup has taken notice, announcing in mid-May that it will dedicate 100 money managers to India's growing nouveau riche. The initiative represents a five-fold increase from current levels.

Profits are likely to improve for Citigroup this year, says Mark Hebeka, an S&P equity analyst. His strong buy recommendation is also based on the company's geographic and product diversity, and on what he views as "the potential for long-term, above-peer-average revenue growth and profitability prospects that we believe are not reflected in the stock's current valuation."

While the earnings impact from emerging markets may be relatively small for these multinational giants, it is likely growing and should not be ignored, say S&P analysts. Frank Braden, an S&P equity analyst, expects expansion-focused MetLife to see its emerging-market operations increasingly contributing to operating earnings.


  "MetLife's international strategy is to establish meaningful positions in growing markets that can provide attractive margins," says Braden. "We expect investments in Brazil and Hong Kong to add to earnings per share in 2008, with operations in India and China turning positive beyond 2008."

Speaking of Citigroup, JPMorgan Chase, and Bank of America, Hebeka says, "Unless there is a major change in demand from emerging markets for financial services, we are likely to stay positive on these companies."

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