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December 18, 2009
Bank Stock Investing

With all of the bank bailouts last year bank stock investing did not seem like a very good idea. However, a strong portfolio often has a bank stock. There are pros and cons to bank stock investing. A well managed bank is a money making machine and a bank with a portfolio of bad loans is a disaster waiting to happen. If you want to get into stock investing in banks you will want to know how banks make their money and what the stock market risks are for banks.

The basic money maker for banks is the difference between the interest that the bank pays and the interest that the bank receives. The bank’s job is to attract savers with sufficiently high interest rates and good service. The bank’s other job is develop a loan and/or mortgage business with sufficiently high interest rates and reliable loan payers so that there is more money coming in than overhead plus what is paid out in interest. The price of bank stock shares and their dividends depend very heavily on how banks handle their loan portfolios.

Traditional bank products include savings accounts, checking accounts, and certificates of deposit. Banks receive money from their customers and then lend it out. The key factor for banks is to develop a loan portfolio with borrowers who reliably pay on their loans. In addition to savings accounts and loans banks offer services such as trust departments, credit card processing services, payment services for merchants, and various service fees. To invest in stocks of banks it is wise to have a clear idea of how the bank whose stock you want to invest in makes its money.

Banks carry a reserve against expected loan losses. If the bank has a substantially larger percentage of non performing loans than expected they will experience losses. A recurring problem in picking stocks in the banking industry is that when interest rates are high and the economy is booming, banks may tend to write loans to borderline customers. Stock shares go up but when the economy goes bad non performing loans increase.

Bank stock investing is about stock dividends and, in some situations, bank growth stocks. Investing in banks can be a good idea if a bank offers a good dividend yield, has more than adequate loan reserves on good quality loans, and has reasonable prospects for growth. A well managed bank may demonstrate excellent growth with multiple takeovers whereas a poorly managed bank may look strong with takeovers and end up disappointing shareholders with losses.

When one sees large banking receiving Federal Funds to help maintain credit in the economy it is not reassuring to individuals interested in bank stock investing. However, one might argue that the bailout money was meant to keep the overall economy going, not to keep individual banks afloat. The economy was in trouble and the stock market looked like it was collapsing. However, there were still stock picking opportunities among bank stocks during the panic to sell and get out of the market.

Bank stock investing is susceptible to the same investing and trading psychology as all stock market investing. When things look bad all stocks drop, including banks that are really in good shape is often a good time in bank stock investing to pick up a good deal or two. Much of the appreciation in bank stocks comes with buying at the bottom of an economic cycle instead of at the top. Picking stocks among banks with strong balance sheets, loan reserves, and performing loans will pay well as the market rebounds.

Investing in banks, like all stock market investing requires that you do stock market analysis and that you continue to do stock analysis in your portfolio. It can be very lucrative if you learn what makes banks tick and pay attention to detail. Often times doing your homework is everything.


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