Analysts Down Under are telling investors to buy into banks. But this is disastrous advice, says Dan. Banking is in terrible shape. Investors would be much better off buying into beaten-down resource and energy firms. It’s now the best time since 2003 to buy a portfolio of world-class projects at very good values. This from Dan Denning…

“Analysts rate Westpac (ASX: WBC) a buy,” says Andrew Carswell in today’s Daily Telegraph. The bank told investors on Friday that it expected profit for the financial year to rise between six and eight percent. Let’s call it seven. But wait. It gets better.

Analysts at UBS raised the price target on the stock to $25, which is about thirty-one cents below where it trades today. Bold! Merrill Lynch (NYSE:MER) says Westpac has the lowest risk, highest quality assets in the Aussie banking sector. It rates the shares a buy too. Zig.

But why not zag?

Is it not obvious by now – one year into the credit crisis – that banking is a terrible business when you strip away the fancy suits and big ties? It is subject to massive blowups and failures. When run prudently, of course, this does not happen. Banks are discrete in their loan-making, maintain adequate capital, and pay investors a dividend for their risk.

For banks to deliver faster earnings growth, they have to take more lending risks. This leads, especially at the tail end of a manic credit boom, directly to the situation you most want to avoid, banks that lower lending standards to grow the portfolio. It also leads, inevitably, higher rates of default.

Why on earth would anyone want to own a business that is structurally exposed to black swan events that destroy shareholder capital? Anyone? Beuller?

The ‘zag’ strategy would be to forget shares altogether until the banking crisis is sorted out globally, in which case you’d be primarily in cash. Or, you could buy shares of companies that are less prone to negative black swans but equally (if not more so) beaten down. Here we have companies like Worley Parsons (ASX:WOR) in mind.

Worley Parsons reported a 53% rise in full year profit today. It’s Australia’s best engineering firm. It’s got business in four different booms: energy, infrastructure, mining, and power. It has clients all over the planet. And as far as beaten down value, it’s down 33% year-to-date.

Here’s what we’d say for the moment: the beat down in the resource market is going to give you the best chance since 2003 to buy a portfolio of world-class projects at very good values. By the end of the year, a smart investor could end up with a buy-and-hold ten-year portfolio of the best resource and energy firms in the world. It’s an opportunity that probably won’t come again for quite some time.

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Sources: Buy Resources, Not Banks