This bank stock's unique combination makes it a bargain

By Philip van Doorn

KBW has upgraded Bank of New York Mellon to an 'Outperform' rating, supported by strong financial performance and a low price-to-earnings valuation

On Wednesday, Keefe, Bruyette & Woods analyst David Konrad upgraded Bank of New York Mellon Corp.'s stock to an "Outperform" rating, citing its "scale, diversification and expectations for widening profitability gap to peers led by strong expense control."

Konrad raised his price target for Bank of New York Mellon (BK) to $70 from $60, while increasing his 2024 earnings estimate for the bank to $5.48 a share from $5.35 and his 2025 EPS estimate to $6.15 from $6.00. His new price target implies a 19% upside over the next 12 months from the stock's close at $58.67 on Wednesday.

Shares of Bank of New York Mellon have returned 14.4% for 2024, with dividends reinvested, through Wednesday. In comparison, the S&P 500 bank industry group had returned a weighted 13.7% and the full S&P 500 SPX was up 15.6%, according to FactSet.

So this has been a very good first half of the year, at least broadly. And banks as a group are valued cheaply when compared with the full S&P 500, based on weighted forward price-to-earnings ratios (current prices divided by rolling consensus 12-month earnings-per-share estimates among analysts polled by FactSet).

This may be familiar territory for investors - the banks as a group nearly always appear cheaply valued relative to the U.S. large-cap benchmark. But now, ahead of a cycle of declining interest rates which will begin eventually to help banks improve profitability as they pay less for deposits, their relative valuations are especially low.

This table shows large-cap banks' weighted forward P/E ratio is in line with five-year and 10-year averages, while the S&P 500's ratios are above those averages:

   Industry group or index    Current forward P/E  Current valuation to 5-year average  Current valuation to 10-year average  Current valuation to S&P 500 
   S&P 500 Banks                             11.2                                 102%                                  100%                           53% 
   S&P 500                                   21.2                                 108%                                  116% 
                                                                                                                                           Source: FactSet 

The S&P 500 bank-industry group's forward P/E valuation is only 53% of the full S&P 500's valuation. Here are two tables, first with the P/E data and second with the banks' average relative valuations to the S&P 500:

   Industry group or index    Current forward P/E  5-year average forward P/E  10-year average forward P/E  15-year average forward P/E  20-year average forward P/E 
   S&P 500 Banks                             11.2                        11.0                         11.2                         11.4                         11.6 
   S&P 500                                   21.2                        19.6                         18.2                         16.5                         15.9 
   Industry group     Current valuation to S&P 500  5-year average valuation to S&P 500  10-year average valuation to S&P 500  15-year average valuation to S&P 500  20-year average valuation to S&P 500 
   S&P 500 Banks                               53%                                  56%                                   62%                                   69%                                   73% 
                                                                                                                                                                                          Source: FactSet 

Believe it or not, the 15-year and 20-year valuations are closer to what the typical bank analyst would consider "normal" relative valuations for large-cap banks to the full S&P 500: 70%.

Comparing Bank of New York's valuation and performance with other large banks

Getting back to the KBW upgrade, Konrad wrote in a note to clients that his price target increase for Bank of New York Mellon reflected "expectations for its ROTCE to near 22%" in 2025. A bank's return on tangible common equity is its net income divided by the carrying value of its common stock less the value of intangible assets, such as goodwill or loan servicing rights.

Using data provided by FactSet, we can show returns on tangible equity (including preferred stock) over the past four reported quarters.

This table shows the largest 20 U.S. banks ranked by average ROTE over the past four quarters, except for Charles Schwab Corp. (SCHW) and Ally Financial Inc. (ALLY), for which the data isn't available. The table also includes forward P/E ratios as of Wednesday's close, along with dividend yields:

   Bank                                     Ticker City                Average ROTE - four quarters  Forward P/E  Dividend Yield 
   American Express Co.                      AXP   New York                                  39.65%         16.6           1.21% 
   Bank of New York Mellon Corp.              BK   New York                                  21.15%         10.2           2.86% 
   JPMorgan Chase & Co.                      JPM   New York                                  20.75%         11.9           2.33% 
   Fifth Third Bancorp                       FITB  Cincinnati                                20.50%         10.5           3.90% 
   State Street Corp.                        STT   Boston                                    18.76%          8.8           3.79% 
   Truist Financial Corp.                    TFC   Charlotte, N.C.                           18.09%         10.3           5.64% 
   PNC Financial Services Group Inc.         PNC   Pittsburgh                                17.18%         11.3           4.08% 
   M&T Bank Corp.                            MTB   Buffalo, N.Y.                             16.42%          9.8           3.67% 
   First Citizens BancShares Inc. Class A   FCNCA  Raleigh, N.C.                             15.97%          8.5           0.40% 
   Huntington Bancshares Inc.                HBAN  Columbus, Ohio                            15.50%          9.8           4.88% 
   U.S. Bancorp                              USB   Minneapolis                               15.28%         10.0           4.94% 
   Capital One Financial Corp.               COF   McLean, Va.                               13.69%          9.5           1.75% 
   Morgan Stanley                             MS   New York                                  13.43%         13.4           3.51% 
   Bank of America Corp.                     BAC   Charlotte, N.C.                           13.40%         11.5           2.46% 
   Wells Fargo & Co.                         WFC   San Francisco                             12.73%         10.8           2.46% 
   Citizens Financial Group Inc.             CFG   Providence, R.I.                          12.21%          9.7           4.83% 
   Goldman Sachs Group Inc.                   GS   New York                                   8.90%         11.7           2.41% 
   Citigroup Inc.                             C    New York                                   4.15%          9.5           3.46% 
   Charles Schwab Corp.                      SCHW  Westlake, Texas                              N/A         19.2           1.37% 
   Ally Financial Inc.                       ALLY  Detroit                                      N/A          9.6           3.01% 
                                                                                                                 Source: FactSet 

Bank of New York Mellon ranks second on the list by ROTE over the past four quarters, but also trades at the lowest P/E among the top four banks on the list. BK's rival with a similar business model - focused on securities custody services and asset management - is State Street Corp. (STT), which ranks fifth and trades at a forward P/E of 8.8 - the second-lowest P/E on the list. Konrad has a neutral rating for State Street.

The only bank on the list with a higher ROTE over the past year has been American Express & Co. (AXP), which has the advantages of predictable fee generation from its charge cards, and high interest rates that customers pay on credit-card balances. American Express's forward P/E of 16.6 is high for a bank but low relative to the S&P 500.

BK ranks ahead of JPMorgan Chase & Co. (JPM), the largest U.S. bank and the one most favored by analysts working for brokerage firms, as can be seen in the last table below.

Another factor Konrad cited in Bank of New York Mellon's favor is his expectation that it will lead large-cap U.S. banks to deploy capital through share repurchases and dividends over the next two years. He wrote that the bank tends to do well in regulatory stress tests because it doesn't focus on lending and has strong capital ratios.

Steve Gelsi's coverage of the Federal Reserve's bank stress test results and aftermath:

Analysts praise banks and puzzle over Fed after stress testsLive updates as reaction pours in

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