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How to Find Bank Stocks With Wide Moats

In this edition of Industry Focus, host Michael Douglass and Fool contributor Matt Frankel discuss banks and their moats. The banking industry is doing quite well, but that doesn't mean all bank stocks are in the same boat. In this video, Michael and Matt discuss how to identify durable advantages in banks, and give an example of a bank stock that should do just fine no matter what the economy is doing.

A full transcript follows the video.

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This video was recorded on Oct. 23, 2017.

Michael Douglass: Let's turn to thinking about a moat. When you've got a big sector like this, and a bunch of different players that frankly are a little bit inscrutable, how does an investor identify a moat for them, and really figure out which one to invest in?

Matt Frankel: That's a really good question. The moat, you can identify basically by something that differentiates the banks from the others and that should keep it going no matter what the market or the economy is doing. U.S. Bancorp is the obvious example, just because they're always profitable, have very few loan losses. The recent stress tests actually found that U.S. Bank would not only survive, but they would make money even in an absolute worst-case scenario. That's a pretty nice moat. That's a good margin of safety to have, too.

Douglass: Yeah, absolutely. I tend to agree. I think one of the other things to keep in mind is management. When you go back to a lot of these metrics that we've talked about, what they really come down to basically is, how smart is management at deploying capital, and how much risk are they taking on by doing so? And the more that you can read about management, hear what they say, hear how they talk about their business, I think the more you can understand a little bit, when you combine it with these metrics, what their credit risk looks like and how they think about investing in the company.

Keep in mind, every bank is going to say they are a conservative lender that's really careful about how it lends out money. That's just sort of par for the course for them to claim that. The reality, though, is going to be that when you combine these different ratios with what management is talking about and really try to better understand how they do this and what risk they're taking on by doing it.

Frankel: Definitely, just to see who's putting their money where their mouth is, I guess, is the best way to sum it up.

Douglass: Exactly. And one more time, as I mentioned earlier, my favorite article on banks is written by Anand Chokkavelu, who's a CFA at fool.com. Drop us a note, industryfocus@fool.com, and I'll be happy to send you that article, which really breaks down how to think about investing in banks.

Frankel: I actually learned a lot of what I know about things from that article.

Douglass: Yes, me too.

Matthew Frankel has no position in any of the stocks mentioned. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.