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Finding Bargains in Battered Banks


The credit crunch won't last forever, and, for now, some players are paying handsome dividends

The bad news in banking keeps coming: Writedowns are piling up, and recession talk continues. But digging through the mortgage mess may prove fruitful. Says Chris Fortune, a T. Rowe Price (TROW) analyst: "Investors are going to want to buy at the darkest days."

Given all the uncertainty, it pays to play it safe. Investors should look for established financial companies that offer a nice dividend. With so many stocks in the dumps, it's not hard to find payouts of 7% to 9%. The key is making sure those dividends won't disappear. For example, Wall Street is worried that Citigroup (C) may cut its dividend in light of its huge losses.

First Horizon's dividend (FHN) isn't in peril, says Fortune. The regional bank's earnings are in a slump. But investors, who are collecting a 9.2% yield, get paid to wait for a turnaround. It's the same story with Fifth Third Bancorp (FITB) at 6.3%. With a new management team, it's poised for growth. Bank of America's (BAC) 5.8% payout looks solid, too, especially considering earnings should rise 30% to 35% next year, says Georges Yared, chief investment strategist for Yared Investment Research.

A different way to brave the battered sector: mutual funds. On average, financial sector funds are off 13% over nearly a year. But T. Rowe Price Financial Services (PRISX) has fared better than most, falling 8.3%. And with more than 80 stocks, the portfolio won't stumble much if one stock blows up. Manager Jeff Arricale has found some good deals in this environment, recently adding to his stake in insurer AIG (AIG) and picking up JPMorgan Chase (JPM).

Davis Financial Fund is another standout, down just 4.7%. Manager Kenneth Feinberg's top performer: China Life Insurance (LFC), which is up more than 50% over the past 12 months. "These funds are doing well because they have stayed diversified," says Andrew Gunter, a mutual fund analyst for research firm Morningstar (MORN).

More intrepid investors may want to consider the stocks of lenders at the center of the subprime storm. Bargain hunters like embattled Countrywide Financial (CFC), which is off 74% since July. At a recent market value of $5.4 billion, the nation's No. 1 lender trades at a 60% discount to its book value—a sign the stock may be a good buy. "Stocks are getting sold regardless of valuation," says T. Rowe's Fortune. "Countrywide won't stay at this price for long."

Wells Fargo (WFC), KeyCorp (KEY), and SunTrust (STI) also have taken a beating. With conservative lending models and strong management teams, says David Ellison, president of asset manager FBR Funds, the companies will be long-term winners. "These stocks will hold up the best through 2008," says Ellison.

If history is any indication, the payoff could be huge. In 1990, the last major downturn in the sector, financials fell 13% amid a recession. But the sector quickly rebounded the next year, returning 40%. Says Tobias Levkovich, a Citigroup analyst: "There is a tendency to wait, but you will get the best purchase price when no one else wants to buy a stock."

Back to Investment Outlook 2008 Table of Contents

Silver-Greenberg is a reporter for BusinessWeek.com.

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