Using Four Simple Metrics, Bank Stocks Return 22% a Year with a Beta of Less than 0.5
by Tim Melvin
As I’ve covered here at DailyAlts.com, banks are facing the combined pressure of the growing complexity of cybersecurity as well as the rise of fintech.
Both long-term trends require banks to invest in technology and expertise that they have not traditionally dabbled in. Late and unsuccessful adopters will suffer, while the best banks will benefit greatly.
To capture returns from these trends, I created a quantitative and qualitative model for selecting bank stocks. I call it the Bank Investment Strategy, and it’s turned out very well.
In backtesting from January 2010 to January 2020, this strategy has returned an average of over 22% a year – with a beta that’s less than 0.5.
That makes for an outperformance of more than 100% over the S&P 500, as you can see in this chart:
The grey line shows the S&P 500 over the past ten years. As you can see, it’s gone up a total of 356% over that time.
The Bank Investment Strategy went up 768% over the same decade. In other words, this bank-focused model outperformed the market by more than 2-to-1 in a decade that included both the dot-com crash and the financial crisis.
And it did this with a beta of less than 0.5.
Here's how it works:
Step 1: The Four Quantitative Metrics
The Bank Investment Strategy does all of this with four quantitative metrics. In my research, I found using these two pairs produced the best results.
The first pair focuses on earnings growth. I call this half of the portfolio the High-Growth Bank Portfolio.
First, I screen for the bank stocks that have grown their earnings over the last five years by a high amount.
Then, I narrow it down by focusing only on the stocks that have a low price-to-earnings ratio, to make sure the banks are undervalued.
The results speak for themselves:
That’s almost twice the market’s return, at a beta of just 0.46.
There’s also not a lot of turnover here. This keeps transaction costs down and allows compounding to do its job.
For the other second pair of metrics, I focus on dividends. This produces a portfolio of income-paying bank stocks that, among other things, help weather any downturns.
First, I screen for bank stocks that yield significantly above average.
Then, I again narrow down the list by focusing on banks with a low price-to-earnings ratio.
I call this the High-Yield Bank Portfolio, and as you can see, the results are stellar:
This half of the portfolio outperforms the S&P 500 by more than 2.7 times. The beta here is just 0.48.
In other words, both approaches have significantly lower volatility than the S&P 500.
The two approaches are also not highly correlated with each other, so they complement each other.
For example, by splitting a portfolio 50/50 between the High-Growth and the High-Yield approaches, you outperform the S&P 500 by more than 2-to-1 with just half the beta:
Of course, you can mix and match these however you’d like, depending on your own preferences.
And that brings us to the second part of the Bank Investment Strategy:
Step 2: Qualitative Selection of Stocks
Like in any investment approach, the quantitative metrics I described above do a great job of narrowing down the selection of stocks.
But at some point, qualitative considerations have come in. For example, both the High-Growth and the High-Yield approaches use PE ratios to look for undervalued bank stocks.
Excluding banks that are trading at low multiples for good reason can only improve performance.
I’ve also found the results to be best when limiting the model to buy the 10 best High-Growth banks and the 20 best High-Yield banks.
It’s in this qualitative part of the strategy that my 27 years in the financial industry really helps.
I’d like to use that experience to help you.
That’s why I’m starting a new service here at DailyAlts called:
The Community Bank Investor Newsletter
It’s a monthly newsletter that tracks my Bank Investment Strategy. It’s the only way to get guaranteed updates on what stocks the model I described above picks out.
Every month, subscribers will receive:
- The 10 High-Growth and 20 High-Yield bank stocks that the Bank Investment Strategy recommends and that can help you outperform the S&P 500 by more than 100% with only half the beta…
- Exclusive commentary on the banking industry and the markets at large…
- Special insights into the markets from my personal network of private equity specialists, Wall Street luminaries…
- Videos where I explain details of the recommendations and the markets…
- And much, much more.
It’s already become a very popular newsletter:
And the price is a very reasonable $199 a year.
To become a member yourself, and get instant access to the Bank Investment Strategy…
All you have to do is click right here to sign up now.
I’m convinced you won’t regret it.
But just in case the Community Bank Investment Newsletter isn’t to your liking…
Simply contact DailyAlts.com within 30 days and you’ll get a full refund of your membership fee.
No “ifs” or “buts.”
There’s very little downside for you.
And an amazing opportunity to outperform the S&P 500 by more than 100% with just half the beta.
Subscribe to the newsletter today:
Community Bank Investor Newsletter
$199.00 / year
The industry’s leading and most outspoken analyst on the community banking space, Tim Melvin brings a consistent track record since July 2013 that has outpaced the S&P 500.