Feb. 05--Just a month after bank and financial stocks ended a horrendous year, those same companies are leading the market.

Bank of America Corp. has seen its stock shoot up more than 40 percent so far this year, leading the Dow Jones industrial average after finishing dead-last in the index in 2011.

A broader measure of the financial sector -- the KBW Bank Index -- fell nearly 25 percent last year. This year, it's up more than 14 percent. Banks of all sizes are on the rise.

What gives?

As wary investors appear willing to take on more risk, analysts say they're being drawn to the cheap prices relative to the banks' book value and earnings.

At the same time, worries in Europe have slackened, and the U.S. economy has seen encouraging signs of growth. On Friday, the government said U.S. unemployment dipped to 8.3 percent, the lowest in nearly three years.

All of that makes stock-pickers cautiously optimistic about the financial sector in 2012.

"We don't think it's going to be a straight-up rise like it's been the first month of the year," said Brian Rudisill of Novare Capital Management in Charlotte. "But it should be a decent year."

Worst to best

By all accounts, 2011 was a bad year for bank stocks. With the industry hammered on all sides -- financial turmoil in Europe, increasing governmental regulation and a still-struggling U.S. economy -- investors fled from financial companies big and small.

That began changing Jan. 1. Besides Bank of America, Citigroup Inc. is up more than 27 percent after being down 44 percent the year before. Midsized banks like Regions Financial Corp. and SunTrust Banks Inc. also have reversed their fortunes.

"The worst performing bank stocks of 2011 have become the best performing bank stocks in 2012," analysts with Stifel Nicolaus wrote in a research note. "Did the fundamental fortunes of all five of these banks simultaneously turn on a dime at the stroke of midnight on January 1?"

No, but perceptions may have.

This year, investors are willing to take on a little more risk, tired of settling for low-yield investments, said Alex Miles, chief investment officer of Charlotte's Kingfisher Capital.

They've been aided by an improving outlook in Europe, after a year in which persistent fears rattled the markets.

The housing market, too, shows signs of stabilizing, Rudisill said.

Financial stocks have benefited mainly because they've been so beaten up the last few years.

Analysts point to the relatively cheap price of the stocks compared with their tangible book value, a measure of shareholders' equity in a company.

For example, Bank of America's tangible book value per share stood at $12.95 at the end of the fourth quarter. It's recently been trading around $7 per share. It closed at $7.84 on Friday.

Financials also are trading at relatively low price-to-earnings multiples.

"The sector is the cheapest sector out there," said Don Olmstead, managing director of Novare Capital Management.

Will it last?

But the fact that the pricing over the last few years has disconnected from banks' financial performance gives some analysts pause.

Banks have reported increasingly strong underlying fundamentals, like growth in loans and capital levels. But the picture hasn't been rosy enough to justify the surge, analysts with Stifel Nicolaus wrote in a research note last week.

If the rally continues, they'll be watching to see whether banks turn in equally robust financial results. If they don't, those analysts are ready to revise their outlook downward.

Analysts with Keefe, Bruyette and Woods also cited the continuing disconnect between stock price and underlying earnings. Valuation has been based more on fear and the news of the day, rather than the earnings reports. Investors' thinking should return to normal this year, they said.

But even if the astronomical improvement of January slackens, some observers predict the sector will outperform the market.

"The stock market has the potential to move substantially higher over the course of the year because of the fact that so much capital is sitting in low-return, low-income-producing products. As it moves back in, it will be a virtuous cycle," Miles said.

"Financials should lead that recovery. ... I think it is going to last."