Will Spanish banking stocks get any cheaper?

Earnings forecasts for Spanish companies are falling every day while prices are 29% higher than the euro zone average for banking stocks. In order to match this average, Spanish banking stocks will have to get cheaper, or the banks will have to make more money.

It?s never easy to find the ideal balance, but there are aspects that suggest that we are on the right path. This is true for the Spanish economy at least, which is on the road to recovery. The banking sector was hit particularly hard by the crisis, but is doing better now. Bank stocks have rebounded between 14% and 83% on the stock market in the past year.

A major trend shift has occured, although not across the board. Some banks that had high hopes for more earnings fell short. Lower earnings expectations mean that Spanish bank stocks are expensive based on their PE ratios compared to other banks in Europe.

Spanish bank stocks are priced at a 29% premium compared to others in the region based on 2015 earnings expectations. Factoring in expected earnings for the year ahead, the PE ratio for the top 25 banks is going higher. "One of the main reasons that Spain banking stocks have a high PE ratio compared to their neighbors in Europe is that they have a lot of money tied up in provisions and own a lot of uncertain real estate debt," explained Javier Urones, an analyst from XTB. Can these stocks make their PE ratios close to the European average? The market consensus from FactSet predicts that they will cut their PE ratios to 22% on average. To do that, their earnings per share will have to go up or their stock prices will have to go down.

Banco Popular saw its earnings forecast plummet. Its shares will have to drop by 19% in value in order to hit the euro zone average price, or reach 3.66 euros per share. Alternatively, if its earnings per share go up 25% to 0.43 euros per share, it could also reach the benchmark.

CaixaBank's price will need to drop 24.4%, and Santander and BBVA will have to shave 14.8% and 12.9% respectively in order to be priced near the European average.

Profits at Bankia, Bankinter and Sabadell have improved their standing in 2014. "This year has been a major inflexion point for the banks in two ways. First, we have started to decrease the number of loan defaults. Second, we have started to regain our profit margins. Both are driving the sector's recovery," said Victoria Torre, a product analyst at Self Bank. But all the gains are not nearly enough considering that these banks are still priced higher than the euro zone average.