Something Could Go Right in Banking

The name Dick Bove may not ring bells for many investors, but if you're sniffing around the stocks of U.S. banks, it's a good name to know.

It's certainly not the only name to know, as folks like Meredith Whitney and Mike Mayo, as well as some of my Foolish colleagues, including Morgan Housel, have had some interesting things to say about the financial industry. Bove, however, is particularly notable because of his persistent confidence in the banking and financial sector. Bove is senior vice president of equity research at Rochdale Securities.

In fact, the title of this article comes from something that jumped out at me in a recent interview Bove did with Steve Forbes. Bove said:

I think the people in my industry and people in your industry are having a hard time getting their mind around the fact that something could go right in banking. In other words, the whole driving force, so to speak, among analysts is, "Find that thing that no one else found yet that is bad about banks. The credit card thing is bad; the commercial real estate thing is bad. You know, they've changed the accounting laws. But find that thing and drive these stocks lower."

Where does he get his crazy pills?
Positive on banking? Isn't that like saying you'd like to buy Bernie Madoff a beer?

Now it's notable that not everything Bove says about banks is lollipops and unicorns. In fact, he just recently reduced his 2009 estimates on both JPMorgan Chase (NYSE: JPM) and Goldman Sachs (NYSE: GS), partly due to the fact that both will face costs associated with their TARP paybacks.

But looking longer term, he seems to like pretty much all the big boys in the sector, from the two above to the more-troubled Citigroup (NYSE: C) and Bank of America (NYSE: BAC).

And he may not be all that nuts. Psychologists have found a wide array of forces that can color people's thinking and cause them to incorrectly interpret situations. The availability heuristic, for example, has shown that people often predict probable outcomes based on how easily an example of the outcome can be brought to mind.

In the case of banks, analysts could be overestimating the potential for future bad outcomes in the industry simply because they can so easily call to mind the recent devastating losses.

Or the good old bandwagon effect could be at play. As the name suggests, this bias causes people to believe something simply because many other people believe the same thing.

As more and more analysts seem to settle on the conclusion that financial institutions from Capital One Financial (NYSE: COF) to Wells Fargo (NYSE: WFC) are in for more tough times, it becomes increasingly difficult for folks like Bove to jump out of step and suggest exactly the opposite.

These two biases could also be working in conjunction, with recent events coloring future expectations and the preponderance of analysts coming to that faulty conclusion, making it much easier for additional analysts to jump on the same off-kilter bandwagon. That is, of course, assuming that Bove isn't simply dead wrong.

Is there an antidote in the house?
If he's right, the most obvious course of action is for those who are still shorting the financial sector to step aside to avoid getting hit by an oncoming train. Bove has suggested that Citigroup could eventually head toward $12 per share, a quadrupling that would deliver more than a flesh wound to a short-seller unlucky enough to be on the receiving end.

For the rest of us, though, it means that it may be worth revisiting the murky world of U.S. banking. If Bove is correct, the banking sector may continue to struggle through this year, but then find itself on the winning end of rapidly expanding earnings once loss provisions start to settle back down. At that point, investors are likely to flock to the sector.

The banks we could expect to pay off the most are those that have been beaten down the most and carry the lowest valuations. Citigroup and Bank of America would certainly qualify, but JPMorgan, Fifth Third Bancorp (Nasdaq: FITB), and M&T Bank are also among the financial institutions trading below book value.

But don't take his word for it
Relying blindly on an analyst -- whether it's Bove or anyone else -- for your investment decisions is a recipe for disaster. While the analyst's initial call may be well publicized, subsequent changes or a complete reversal may not be, and that could leave you out in the cold. So if you like the sound of Bove's conclusions, use them as a jumping-off point for your own research into specific banks or the macrofactors of the financial industry.

And if you want to get a few more opinions on which stocks look interesting in the financial world, check out what the 135,000 members of the CAPS investing community have to say about the industry.