Back in the 1980s, Peter Lynch, the famed head of Fidelity’s flagship Magellan fund, stumbled across an industry that he found to be undervalued and underfollowed by Wall Street. To paraphrase his analysis in his popular Beating the Street book, Wal-Mart (NYSE: WMT) and Philip Morris had nearly 50 analysts covering their stocks, but the stocks he found received scant analyst attention because they were seen as too small and boring to follow.

The stocks Lynch snapped up were mom-and-pop local banks, or what he termed the “Jimmy Stewart S&L’s,” or local savings and loan banks (S&L), reminiscent of the one chronicled in the movie “It’s a Wonderful Life.” Lynch found a handful of small bank stocks that at the time sported high dividend yields, traded at low book-value multiples, and could be had for price-to-earnings (P/E) ratios between 7 and 8. The banks were also growing at 15% or more each year.

S&Ls at the time were also largely out of favor due to the S&L crisis in the late 1980s that saw hundreds of banks fail, largely due to a real-estate bust in Texas. About half of the failures were in Texas, but the entire industry sustained a black eye that sent many profitable players into the bargain bin. But Lynch bought nearly every small bank he could get his hands on and it proved another successful strategy that helped him grow Magellan’s assets from $18 million to $14 billion within 13 years.

An adage is that history may not repeat itself, but it surely does rhyme. The recent credit crisis has left many banks and financial firms out of favor. Interestingly, a financial reform effort to shutter a large regulatory body overseeing the nation’s S&Ls is causing many private firms to consider going public and avoid the uncertainty that regulatory changes can bring. This creates an opportunity for investors to follow Lynch’s lead once again.

Given the lack of interest in investing in financial firms, there is the potential to pick up newly public S&Ls on the cheap. Prior to going public, these banks are referred to as “mutual savings banks” and are owned by their depositors who have voting rights and the opportunity to invest in the firm when it goes public. In addition, a number of firms just recently went public and could be fertile grounds for finding stocks with low valuations and compelling growth outlooks.

Lynch touted that local banks can be more profitable than large money center banks. He cited Citicorp, which has since morphed into Citigroup (NYSE: C) after years of acquisitions, as an example. According to Lynch, the bigger banks have more overhead, such as large headquarter buildings and the need to spend on national advertising campaigns. A smaller bank doesn’t have these requirements and also has access to stable and profitable deposit bases in more rural communities that larger banks are likely to avoid. Finally, small banks can win on customer service because they are more involved in their smaller communities.
  
Action to Take —> For individuals in smaller communities, banking at a mutual savings bank could be a ground-floor opportunity to buy shares in a public offering. For the rest of us, we can wait for these private companies to go public. SNL Financial, a market intelligence group, tracks all thrift banks so it is a good place to keep an eye out for local banks that plan on going public. It is estimated that there are still about 600 private banks that could go public in the coming years.

As I also mentioned, a number of these banks are already public and available to investors. Better yet, many are currently trading at appealing levels and have minimal coverage from Wall Street analysts. A firm that could turn out to be solid pick is HF Financial Corp. (Nasdaq: HFFC) because it trades at a significant discount to book value, while Oneida Financial Corp. (Nasdaq: ONFC) has a very appealing dividend yield of almost 6.0%

Both HF Financial and Oneida Financial have low earnings multiples, high dividend yields and just sold shares to the public. HF Financial trades at a P/E of less than 11, has a 4.3% yield and trades at 82% of book value. Oneida’s P/E is slightly higher at 15.8, but so is its dividend yield, and it trades at only 67% of book value. (A general rule of thumb is to buy a bank at or below book value and sell it when it reaches two times book value.) Banks that sell below book value usually have quite a bit of potential upside when bought at such low levels.