USB is down more than -23% in the past year. How big is its discount?

One of the core principles about technical analysis that was drilled into my head early in my investing career is that “the market is always right.” That idea is designed to disconnect a person’s bias about a company from the investing decision and instead learn to rely on the stock’s price action to drive a more objective approach to trade timing as well as what kind of trade to make – buy, sell, or stay away.

Early in my investing career, I put a lot of focus on understanding technical concepts like identifying short-term reversal points as support and resistance, trend formations over time, and how all of that information can be applied against a stock’s current price to recognize signals about a stock’s likely direction across multiple time periods in the future. Those principles put “the market is always right” into a clearer context and made it easier to separate whether or not I liked the company or their core business from a practical investing decision.

For some, the mindset I just outlined tends to dismiss the value argument, which relies on the company’s underlying fundamental strength to drive an evaluation about what the stock should be worth. Pure technicians operate on the basis that the market prices in all available information about a company into its stock at all times, no whether that information is qualitative, quantitative or otherwise, which means that whatever a stock’s price is today, that is where it probably should be. It’s why swing and momentum traders don’t care so much about what a stock’s price is right now as much as which way it’s going right now, and what that direction might say about where it is likely to go next.

In the years since I cut my teeth on those technical concepts, as I’ve studied and learned more about fundamental and value-based principles, I’ve learned to combine the best of both the technical and fundamental viewpoints into the system I use now. Understanding where a stock is right now in relation to its trends helps to shape my viewpoint about the probabilities of also identifying stocks at useful valuation levels. Sometimes, those principles work well in concert with each other and at other times they seem diametrically opposed. The longer a bull market lasts, for example, the harder it gets to find stocks with the ideal combination of a value and fundamental-driven discount with a trend that leads me to also believe potential downside could be limited.

The Financial sector is a good example of what I mean. From early in 2020 until the beginning of 2022, the sector was one of the biggest stars of the market. As interest rates have increased this year, however, the opposite has held true, as the sector dropped nearly -30% from its January high to its October low as measured by the U.S. Financials iShares ETF (IYF). Even though the sector has rebounded since then, it remains a little under -20% down for the entire year. That means most of the stocks in the sector have also been falling over the same period. While a long-term downward trend makes a lot of investors shy away, I’ve learned to gravitate to this situations, as the odds that stock prices begin to trade at significant discounts compared to the value of their underlying businesses increase.

In the Financial sector one of the stocks that I like to pay attention to is U.S. Bancorp (USB). While this company will usually not get mentioned on news media when talking heads start talking about the largest banking institutions in the U.S., it is the 6th largest bank in the U.S. by deposits. They boast a very healthy balance sheet with liquid reserves well in access of debt obligations and a healthy dividend that makes tempting fodder for income-seeking investors. The stock itself has followed the sector low and is down more than -23% over the past year. Does that mean that this is a stock that could also offer an attractive value opportunity? Let’s find out.

Fundamental and Value Profile

U.S. Bancorp is a financial services holding company. The Company provides a range of financial services, including lending and depository services, cash management, capital markets, and trust and investment management services. It also engages in credit card services, merchant and automated teller machine (ATM) processing, mortgage banking, insurance, brokerage and leasing. Its banking subsidiary, U.S. Bank National Association, is engaged in the general banking business and offers commercial and consumer lending, lending services, depository services and ancillary services. Its non-banking subsidiaries offer investment and insurance products to the Company’s customers principally within its domestic markets, and fund administration services to a range of mutual and other funds. The Company’s bank and trust subsidiaries provide a range of asset management and fiduciary services for individuals, estates, foundations, business corporations and charitable organizations. USB’s market cap is about $66.1 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined a little over -9.2%, while sales increased almost 18%. In the last quarter, earnings improved by 8.26% while sales were nearly 13% higher. USB’s margin profile is very healthy; Net Income as a percentage of Revenues was 26.01% over the last twelve months, and moderated only slightly in the last quarter to 25.18%.

Free Cash Flow: USB’s free cash flow was nearly $15 billion over the past twelve months and translates to a Free Cash Flow Yield of 23.27%. It has also increased over the past year, from $9.87 billion at the end of 2021.

Dividend Yield: USB’s dividend is $1.92 per share, and translates to an above-average yield of 4.44% at its current price. It has also increased from $1.68 per share in the first quarter of 2021, which further confirms the company’s overall fundamental strength.

Debt to Equity: USB has a debt/equity ratio of .78. This is a manageable number. Their balance sheet shows $41.6 billion in cash and liquid assets against about $32.2 billion in long-term debt.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target a little above $62 per share. That means the stock is significantly undervalued, with about 44% upside from the stock’s current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: This chart traces the stock’s movement over the last  year. The diagonal red line traces the stock’s downward trend over the past year, from a high at around $63.50 to an October low at about $38. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. Over the past two and a half months, the stock has settled into a consolidation range, with current support at around $42 per share, and immediate resistance at around $45. A push above $45 should see near-term upside to $48, where the 38.2% retracement line should act as next resistance. A drop below $42 could see the stock fall to about $40, with additional room to about $38 as next support if selling momentum accelerates.

Near-term Keys: USB offers a compelling value-based opportunity, however an environment of increasing interest rates should be expected to limit upside on the stock price, meaning that taking the stock as a new investing opportunity should be considered a long-term proposition. If you prefer to focus on short-term trading strategies, a push above $45 could provide an interesting signal to buy the stock or work with call options, with $48 providing a nice bullish profit target. A drop below $42 could be a signal to short the stock or buy put options, using $40 as a practical, initial profit target, and $38 if bearish sentiment strengthens.

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