Wells Fargo upgrades bank stocks, names Bank of America its top pick for financials

Published Mon, Jan 9 201710:38 AM EST

Wells Fargo Securities on Monday upgraded large-cap U.S. banks to overweight from market weight, citing the potential for corporate tax reform and deregulation to boost earnings for financial firms. The investment bank named Bank of America its top pick in the industry for 2017. "We see up to 26% EPS [earnings per share] upside potential for the banks in 2018," equity analyst Matthew Burnell wrote in a note to clients. Wells Fargo believes a combination of higher interest rates, faster GDP growth, lower corporate taxes and industry deregulation under President-elect Donald Trump could propel bank stocks to new highs in the months ahead. Since Nov. 8 election, the S & P financial sector is the best performing industry group, up nearly 18 percent compared with a return of 6 percent for the S & P 500. S & P financial sector, 1 year Source: FactSet About 60 percent of the increase in earning among financial firms will be derived from lower corporate taxes, according to Wells Fargo's estimates. Trump has proposed lowering corporate taxes to 20 percent from 35 percent. Even though valuations for financial firms reached the highest since the financial crisis, Wells Fargo predicts future upside earnings revisions could cause those metrics to return to attractive levels. "We estimate the prospective positive EPS revisions leave pro-forma 2018 P/E multiples at 11.5x and 10.1x, respectively, 10% and 20% below the group's 25 year average P/E of 12.7x," Burnell said. Bank stocks currently trade at 15 times forward earnings. The analyst singles out Bank of America as its top pick in the space due to the firm's strong balance sheet, shrinking expenses and expanding capital returns. "BAC shares currently have 15% upside potential to our current valuation range (based on our current base case EPS estimates), the highest in our coverage universe. Additionally, we could envision 55% potential upside over the next 12-18 months in a bull case scenario driven by the bull case scenario described above," the analyst said. In the next 12 months, Wells Fargo forecasts shares of Bank of America could trade at $24 to $26. "Potential upside to Trump policies appears greater than peers, in our view," Burnell said in reference to Bank of America. Other top picks by Wells Fargo include Citizens Financial Group , BB & T , U.S. Bancorp , Discover Financial Services and JPMorgan .

Pedestrians pass in front of a Bank of America branch in New York.

Scott Mlyn | CNBC

"We see up to 26% EPS [earnings per share] upside potential for the banks in 2018," equity analyst Matthew Burnell wrote in a note to clients.

Wells Fargo believes a combination of higher interest rates, faster GDP growth, lower corporate taxes and industry deregulation under President-elect Donald Trump could propel bank stocks to new highs in the months ahead.

Since Nov. 8 election, the S&P financial sector is the best performing industry group, up nearly 18 percent compared with a return of 6 percent for the S&P 500.