Morningstar Advisor - Winter 2008 - 79

To make sure we are being contrarians, we suggest focusing on stocks that had recently underperformed the market. We use the S&P 500 as our benchmark and search for stocks that have underperformed it. As of this writing, the S&P 500 return for the year is about 2.5%, so any stock that returned less than that meets our criteria. US Bancorp USB mortgage storm turns into a recession. Cathay General Bancorp CATY And Total Return YTD , 2.5% US Bancorp USB is one of the most diversified and profitable banks we cover. It operates a branch network stretching across 24 states, reducing the effect of regional economic slowdowns. US Bancorp also generates a boatload of fees, (accounting for nearly 50% of its revenue), which reduces its sensitivity to interest-rate changes. While the market might have some concerns about its subprime loan book, these loans are only to 1.8% of total assets. TCF Financial TCB If I had to pick one single ratio to describe the profitability of a financial services company, I would probably use the return on equity (ROE) ratio—net income as a percentage of average common equity. When we search for safe bets in the financial services sector, we are better off narrowing our search to companies that have generated a decent ROE. For the purpose of our screen, we will use 12% ROE as our hurdle rate. And ROE % Year 1 . 12% TCF Financial is one of the most profitable banks in the country. Its return on equity is typically higher than 20%, a rare level for any bank. TCF provides retail and commercial banking services in several Midwest states. The bank positioned itself as the convenient banking choice for the average Joe, leaving other banks to squabble over high-net-worth individuals. The bank also enjoys a stable stream of fee income that’s likely to keep flowing even if we head into a recession. BB&T Corporation BBT Cathay General is based in Los Angeles, in what was one of the hottest real estate markets as of late. Cathay also has a large exposure to commercial real estate in southern California and a sizable construction loan portfolio. But we think the market misses the fact that Cathay is a niche player that caters to Chinese-Americans. Its clients are diligent savers who tend to take few financial risks and detest high levels of debt. This has translated into low levels of loan losses and stable growth over the years. Fulton Financial FULT Fulton Financial is a super-community bank in the mid-Atlantic region. It operates about 11 small community banks and focuses on small businesses and consumer lending. Fulton had its share of problems when the real estate market started to collapse, but we think that in the long run the bank has bright prospects and will probably weather off the headwinds created by the turmoil in the real estate market. SunTrust Banks STI Finally, we want to reap the highest possible return, and the best way to do is by buying stocks that are selling at a large discount to our fair value estimate. Our star rating for stocks rates offerings based on the comparison of a stock’s price to our estimate of its fair value. The cheapest offerings get 5-star ratings and the most expensive get 1-star ratings. Thus, 5-star stocks offer the highest expected return. And Morningstar Rating 5 {{{{{ BB&T main markets are in the Mid-Atlantic, which provides a wealthy and growing customer base. BB&T has been through several credit cycles, including the last downturn in the early 1990s, and while we think that BB&T might see higher loan losses down the road, we think it has a large cushion for pain. Home prices in most of its markets are holding up, making the real estate downturn more of an over-supply issue, which with a growing population will be resolved naturally. Associated Banc-Corp ASBC With a footprint that is the envy of every bank out there, SunTrust is one of the premier Southeast U.S. banks. SunTrust operates in a market with one of the highest projected population growth in the country. With a new CEO at the helm and a strong balance sheet, we think SunTrust is a safe bet in this environment. K Micheal Kon, CFA, is a stock analyst with Morningstar. Though you can certainly broaden your own searches by revising our criteria, we think that these names look like relatively safe bets, but still they remain very contrarian. Here are profiles of seven of the names from our results on Nov. 30. Associated Banc-Corp is a conservative regional bank with nearly $21 billion in assets. It operates more than 300 branches primarily in Wisconsin, Minnesota, and Illinois. The market is very concerned about short-term credit problems, but we don’t think this will be an issue in the long run. Associated is known for being conservative underwriter, and we believe it will be a safe bet even if the MorningstarAdvisor.com 79

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Morningstar Advisor - Winter 2008

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