GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Stock Market Pitching a Fat One Down the Middle with American Bank Stock Prices?

CanadianValue

CanadianValue

209 followers
My gut tells me that we have a big investment opportunity today in American banks. The problem is that my brain tells me that there is no way I have the expertise to figure out exactly what is on the balance sheet of these entities.

I’ve never been convinced that people inside banks are fully aware of the real risk that lies in their assets. I mean how many loans get underwritten by branches that are supervised by some guy who will never even meet the executives who run the bank? A bank is only as good as its internal controls on its underwriting standards. And internal controls are only as good as the people using them. And we all know what people are capable of. These are huge institutions that rely on the effectiveness of their systems. That frightens me.

However. While I can’t really drill into those assets to the level I would like. A person could always take a basket approach to such a contrarian investment if you believe that an entire sector is likely wildly undervalued. It reduces the risk of betting too much on one bad seed, and allows exposure to the simple premise that banks will survive and generally are in pretty good shape.

I saw this article and interview with Dick Bove and I have to admit it made a lot of sense to me:

The stock market is "simply flipping out" by selling off American banks, but the drop in their European counterparts is justified, Richard Bove told CNBC Thursday.

The selling in U.S. banks is "ridiculous," the Rochdale Securities banking analyst said on a day when the Dow Jones Industrial Average is down about 4 percent.

"Take a look at Bank of America (BAC) bonds today, it’s flat. If you look at Goldman Sachs (GS) bonds today, they’re actually up a little bit. So the bond market is telling you that there isn’t a risk in the American system. The stock market is simply flipping out," he said.

But the selling in European banks is justified because of the continued uncertainty. He said these banks "have to give these countries that can’t repay their debt three to five years of [a] debt-free period. They don’t pay their principal back and you cut their interest rates at the same point in time. As a result, that gives them a chance to build up some cash flow to improve their economies."

But he also wants European banks to be forced to "write these loans down to what the true value is. We can’t tell if tomorrow morning Greece wakes up and says, 'We’re going to be just like Argentina. We’re not going to pay you back ever.' Then banks will have to write this back down. So these banks have got to write down their assets to real value."

Finally, "You need a strong group of central banks — China, the U.S., Europe — to put together a pool of money that can be accessed by the banks to rebuild their capital."

Here is the video:



Rather than try and wade in here myself and buy a basket of banks, I think the smart move is to enlist the services of a proven financial sector investor to do it for me. And what I’m thinking is that buying into the Fairholme Fund, or buying stocks that mimic the Fairholme Fund’s huge exposure to the financial sector is a terrific strategy.

These were the main holdings of Fairholme as of their last semi-annual report:

Top Ten Holdings

Berkshire Hathaway (BRK.A) 7.2%

AIA Group 6.7%

Sears Holding Corp (SHLD) 6.4%

Bank of America Corp (BAC) 5.7%

Brookfield Asset Management (BAM) 5.6%

Goldman Sachs (GS) 5.5%

Citigroup (C) 5.5%

Morgan Stanley (MS) 5.3%

Regions Financial (RF) 5.3%

Total of Top Ten Holdings 71.2%

Buying now we are certainly getting a big discount from the price Fairholme paid. I’d suggest buying the stocks directly might be the better strategy as Fairholme is likely going to be struggling with redemptions for some time which could impact its performance to some degree.

Another alternative is to simply follow Buffett and Prem Watsa and buy the higher quality banks such as Wells Fargo. It is hard to imagine that with Buffett’s 20-plus years as a major shareholder that he doesn’t have a good feel for everything about WFC. And he is still buying today.

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 4.0/5 (24 votes)

Comments

superguru
Superguru - 2 years ago
Excellent post. Thats what I am struggling with too, should I buy high quality assets like JPM and WFC at fair prices or low (or unknowable) quality assets such as BAC, C and AIG for presumably very cheap prices?

So far my portfolio of high quality assets has outperformed my portfolio of low quality assets, Even though I thought I bought the low quality assets at really cheap prices. Luckily I am majority in high quality assets.

How about ETF like XLF?
jrhubbard
Jrhubbard - 2 years ago
The long-dated warrants on Bank of America and AIG are interesting as well, and are held by the Fairholme Fund. You could hold a larger share in stock of the high-quality financials and supplement it with a smaller holding of these warrants. I would never play that game with call options, but the warrants expire in 2021, which makes them fairly slow-melting ice cubes.
Kenster
Kenster - 2 years ago


Consider the KBE ETF which holds a basket of Bank stocks.
dmoconnor
Dmoconnor - 2 years ago
Buffett stated “Last Monday, we spent more money in the stock market buying than any day this year.” Not a stretch to think it was WFC, his favorite bank.

w1omega
W1omega - 2 years ago
I've considered financials too. Recently I read that Soros is 70% in cash and thinks depression is possible if Europe's leaders do the wrong thing (I think his macro economic predictions are incredible and his explanation always make sense whether he ends up being right or not). Buffett also says he worries about European problem spilling over to the US on a recent interview with Charlie Rose. Jeremy Grantham's recent letter sounded alarms about the general stock market. Tread water carefully gentlemen.
chihin
Chihin - 2 years ago


Don't forget Bank of New York Mellon (BK). Risk-wise, it's not a bank, but is currently being priced like one...
adamcz
Adamcz - 2 years ago
"Buffett also says he worries about European problem spilling over to the US on a recent interview with Charlie Rose."

He didn't say that. He said that's the only scenario that could cause a double dip recession, and that he doesn't think such an event is likely.

buffetteer17
Buffetteer17 premium member - 2 years ago
Exactly my problem. I sense tremendous value in US financials, but I'm not equipped to evaluate them in detail. Maybe nobody is, i.e., maybe their public disclosures just aren't sufficient to permit deep evaluation. I've always respected Berkowitz's ability to spot value and dig deep to find hidden flaws, and now that he's turned almost entirely to financials, I've bought some FAIRX...let him do the work. My stake is about 4% of my stock portfolio, and it is currently down about 3% from my basis cost.

I would not dare to bet a large percentage of my stock portfolio, which is the majority of my retirement funds, on US financials, but I will let my FAIRX stake grow to 5-6% if the price goes down significantly. Other than FAIRX, I have no material exposure to financials.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Email Hide