1 bank and 2 oddball companies have plenty of room to move higher.

People often think only of banks when they think of the financial sector.  This would be terribly limiting to one’s investment portfolio if banks were the only financial services provider out there.  In fact, financial services reach deeply into the human experience and they are often the source of multibagger returns.

While I have one bank listed in this article, I also mention two other stocks that most people would overlook. They aren’t household names.  One is a regional operator that few outside of the region know about, and the other operates in a sector that most people would actually hate to be involved in.

Invest in the Financial Sector with These 3 Stocks

financial-sectorBank of America (NYSE:BAC) is my banking selection.  There are many great banks in both the US and global economies, but I want a bank that has great capital gain opportunities because it is perceived as being problematic.  B of A took a lot of heat and a lot of losses during the financial crisis.  However, it’s fire-sale purchase of Countrywide placed it at the forefront of the mortgage servicing business going forward.

While everyone else was panicking over toxic mortgages, B of A scooped up Countrywide for its servicing platform, not for its assets.  This was a great move.

Having come out of the crisis in solid shape, B of A is not only a gorilla in mortgage servicing, but it has a massive banking presence in the US.  You cannot go to any major city without finding B of A branches.  B of A is also pushing its credit card products, thanks in no small part to an increase in the use of credit cards among US households over the past two quarters – a reversal of a five-year trend.

The bank got bad publicity from a math error in its financials, which set back its plan to offer a dividend increase.  The stock sold off on this news, but that was a silly reason to sell off.  It wasn’t fundamental to the business.  I think B of A is grossly undervalued considering all these points, and disagree with colleague Stephen Mauzy.

Conn’s (NASDAQ:CONN) operates in the rent-to-own sector, an area I long thought had been saturated.  Yet Conn’s continues to expand in its region, the southwest.  I like the RTO sector because of its economics.

People who cannot afford to purchase new appliances rent them instead, with a buy-it-later option.  Rental fees collected over time exceed the merchant’s purchase price, so I often compare it to the timeshare model.  Borrow cheap money, use it to purchase the products, then rent the product out at a price that will return multiples of your investment over time.  Thus, RTO is a cash-flow rich business.

Conn’s is also outflanking the competition by offering products the massive chains don’t: mattresses and furniture.  Its 75 locations is nothing compared to Aaron’s 2,115. But as a smaller company, it has room to grow and can therefore return multiple on one’s investment.  In FY14, revenues are up 38%, same stores sales are up an unfathomable 26.5%, and EPS increased 63%. EPS is slated to grow 40% this year, and 30% the year after. I think this undiscovered growth play is worth buying into at only 16x this year’s earnings.  A 50% gain seems easy to obtain, and that makes this a real growth stock, but also a value play.

My final choice is Encore Capital Group (NASDAQ:ECPG), which engages in the unenviable task of collecting on bad debt.  This industry is rapidly consolidating, as Encore and others are buying up smaller players.  Encore is also internationally diversified, as bad debt has no borders.  It invests in all kinds of bad debts, from credit cards to bankruptcies, and buys the debt so cheaply that collecting even a few pennies on the dollar results in massive ROI.

Encore is going to benefit from US federal regulation that is cracking down on how bad debt gets sold off.  Sellers are afraid of being hit with regulatory action, so they are being very careful to only sell to collectors with strict compliance programs.  Encore can afford these.  Competitors have a harder time.

EPS is growing at 15%.  With FY14 earnings of $4.41, the stock should trade around $66, yet trades at $44.  That’s a 50% increase from here.

Lawrence Meyers owns shares of B of A.

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