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Big Funds With Big Bets on Financials

These noteworthy offerings have substantial stakes in this unloved and undervalued sector.

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Financial-services firms, at the epicenter of the recent economic crisis, not only suffered some of the worst bear-market losses but have also failed to stage as strong of a rebound as the broad market since early 2009. During the past three years, the typical stock in the sector has lost 7% on an annualized basis, whereas the S&P 500 has squeaked into the black during that time period. Financials stocks have also led the recent sell-off, skidding 5% during the past month alone.

There are fundamental reasons the companies have struggled. In a recent report, Morningstar financial equity analyst Jim Sinegal mentioned some key risks that might contribute to investors' continued aversion to financials, including the European sovereign debt crisis, regulatory and legal uncertainties, and credit issues born out of stunted asset and revenue growth. In fact, even those investors who didn't lose money in the global financial crisis "have essentially sworn off the stocks, much like Mark Twain's cat avoiding all stoves after sitting on a hot one," Sinegal wrote.

But times of trouble can also create opportunity. Even though Sinegal thinks the sector isn't as undervalued as it could be, given the long list of potential headwinds, Morningstar's stock analysts think that the financials in their coverage universe, on average, are trading about 10% below our analysts' estimates of their fair value. That's pretty compelling when you consider that they think the market overall is trading roughly in line with their fair value estimates.

Sinegal wrote, "Some of the highest-quality names, such as  Wells Fargo (WFC) and  J.P. Morgan (JPM), are well capitalized, profitable, and still trading at significant discounts to our fair value estimates and reasonable multiples of current earnings--even without future improvement. We think that in many cases, investors are being fairly, if not amply, compensated for all of the risks facing the sector."

Esther Pak does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.