The financial services sector has underperformed so far this year, with the Morningstar U.S. Financial Services Index returning 4%, compared to 18% for the S&P 500.
As of June 30, more than half of the financial services stocks that Morningstar covers traded below its fair value estimates. The most opportunities lie among credit services firms and banks, says Morningstar analyst Michael Wong.
Here are three major stocks the firm sees as undervalued.
Berkshire Hathaway
(BRK.B) -)
Morningstar moat (durable competitive advantage) rating: wide. Morningstar fair value estimate: $370. Thursday’s closing price: $343.50.
“We believe that Berkshire, owing to its diversification and lower overall risk profile, offers one of the better risk-adjusted return profiles in the financial-services sector,” wrote Morningstar analyst Gregg Warren. And, “it remains a generally solid candidate for downside protection during market selloffs,” he said.
“We’re impressed by Berkshire's ability in most years to generate high-single- to double-digit growth in book value per share, comfortably above our estimate of its cost of capital,” Warren said.
“We believe that it will take some time before the firm finally succumbs to the impediments created by the sheer size and scale of its operations.” And he’s not worried about the ultimate departure of Warren Buffett and Charlie Munger from Berkshire.
Blackstone
(BX) -)
Morningstar moat rating: narrow. Morningstar fair value estimate: $105. Thursday’s closing price: $102.75 (the stock has soared 12% since July 7).
“We consider Blackstone to be the preeminent alternative asset manager, with $991 billion in assets under management (AUM) as of March 31,” Warren said.
“The company has scale in each of its four business segments.” That includes: private equity, real estate, credit & insurance, and hedge funds.
“Blackstone has also built out a large base of employees -- including in-house executives, consultants, and advisers,” Warren said. “They have decades of industry experience and can successfully revitalize a company or property through cost-cutting, acquisitions, or other strategic maneuvers.”
And “these attributes have provided Blackstone with the ability to not only gather but retain assets in various market conditions as well as providing a means of differentiating itself from peers,” he said.
Citigroup
(C) -)
Morningstar moat rating: none. Morningstar fair value estimate: $73. Thursday’s closing price: $47.70.
Citigroup has an international commercial banking operation and a domestically-focused retail banking segment, notes Morningstar analyst Eric Compton.
Within the bank's commercial operations, Institutional Clients Group (ICG), Citi has large trading, investment banking, international corporate banking, and custody operations.
“ICG is Citi's most unique business unit, as its global footprint is hard to replicate,” Compton said. “This international presence will help Citigroup remain a bank of choice for companies with cross-border needs.”
The bank's other main segment is the personal banking and wealth management unit. It’s composed primarily of a U.S.-focused credit card business, Compton said. “This unit has had mixed results over the years.”
Bottom line: “Citigroup is in the middle of a major turnaround and remains a complex story,” he said.
The author owns shares of Berkshire Hathaway and Blackstone.
