I was taken to task recently by a reader and subscriber over my constant use of the Sterne Agee study on activists and community bank stocks.
I use it all the time, most recently in a Real Money article on building an Earl Weaver portfolio. I wrote last week, “The ultimate three-run homer portfolio is community banks stocks with activist involvement. You may recall the Sterne Agee study released in late 2014 that detailed what happens when activists take a position in a community bank. Analyst Matthew Kelly and his team looked at 80 13D filings from known bank stock activists between 2004 and 2014. What they found was that the average stock outperformed the Nasdaq Bank Index by 29 percentage points during the holding period; 29% of the banks were eventually taken over.”
He pointed out that the holding period was generally longer than a year so the outperformance over time was actually less than the piece might imply. That’s a more than fair point as bank activists tend to hold these stocks for several years and that 45%-plus total return during the holding period is nowhere near that on an annualized basis.
This of course made me very curious, so I started doing a little research. Looking at the current portfolio of Joseph Stilwell, he has 22 13D positions in his portfolio that have been held for more than a year. Some were bought as far back as a decade ago. I computed the annualized returns from the close the day he filed the 13D through Thursday, and the numbers are not bad at all. The annualized returns of his current 5%-plus positions is a solid 15.28%. That compares favorably to the broad market and bank indexes over the past five and 10-year periods. But as the commercial says, "Wait, there's more." He has had nine 13D positions sold at a gain over the last several years, and adding these results is going to raise the return a few percentage points.
PL Capital currently has nine stocks in the portfolio where it owns 5% or more of the bank. The annualized return for these holdings is about 13.63%. Once again they have had several takeovers over the years that are not in the current portfolio, so we should add that to the overall total return, but it is above the market and relevant indexes for the past five- and 10-year periods. Their 13D filings are not as self-congratulatory as Stilwell's; it will take some more digging to get the exact number of closed 13D positions and actual returns, but I will be working on it.
I ran the numbers of Basswood Capital this morning. It doesn’t file a lot of 13Ds and is satisfied with being a passive shareholder much of the time. However, if it does file a 13D, it pays to take heed. Its 13D positions over the past 10 years have turned into a stellar 36% annualized returns with most of the filings ending in the sale of the bank.
I am going to be doing a closer study of bank stock activist annualized returns in the weeks and months ahead. Time allowing, I will expand it to the 13G nonactivist positions taken by bank stock specialist investors like Maltese Capital. It is a fascinating topic, and hopefully we can learn some things that make us money over time.
There are a couple of caveats to all this. To capture the return,s you have to be closely watching the 13D filing and buy your shares right around the level the activist paid. The activists tend to hold for an extended period, so if you are looking to get rich quick, this won’t work for you. This is get rich in a long boring process and letting compound returns work in your favor. Not every 13D filing leads to high returns. No one has a 100% hit rate in this business. Some will be duds. The research I have done so far shows that most of the duds are small losses, but do not go into this with the expectation that every single 13D filing will lead to huge returns. Most should work out favorably and your compound rate of return should more than compensate for the work involved. Of course, you always have the option of letting me do the work for you as we track all the small bank 13D filings in Banking on Profits Monthly. In fact, at less than $17 a month, it is probably the smart way to follow 13D filings!
We had the Fed minutes out this week and I continued my new policy of napping through the news release. My new Fed napping system is proving to be sound policy now that baseball season has started, and I have been able to watch more West Coast baseball the nights before Federal Reserve news releases.
Reading the first part of the minutes yesterday, you would swear we were in a boom period with all the positive statements about housing, jobs, business spending and consumer activity. However when you get to crunch time, we find that “The Committee expected that economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate, and that the federal funds rate was likely to remain, for some time, below levels that were expected to prevail in the longer run. Indeed, several members noted that their current projections of the path for the federal funds rate that would likely be appropriate this year and next were lower than they had projected in December.”
The Fed is still very concerned with the risks of a shock and the outlook for the global economy. The report said that “the risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff's assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks; in addition, global economic prospects were still seen as an important downside risk to the forecast." It all still adds up to better but no good in my opinion. One step forward, half a step back and slow growth for a sustained period of time.
Bank of America Merrill Lynch put out a report this week that noted that its clients were sellers of stocks in the past month even as prices rallied. The report noted that “Since early March, all three client groups (institutional clients, private clients and hedge funds) have been sellers of US stocks, led by institutional clients, suggesting that clients continue to doubt the sustainability of the rally amid the lack fundamental drivers.”
Crunching the numbers in the report, it appears that corporate buyback programs have provided more the 90% of the net equity buying so far in 2016. Dubravko Lakos-Bujas, JPMorgan's head of U.S. equity strategy said in his recent client letter that “We think this recovery has been largely driven by fundamentally insensitive strategies and broad-based short covering. With most of the technical factors having already run their course and with equity valuation at elevated levels, we believe a reacceleration in earnings growth and weaker dollar are needed to warrant a more constructive view on U.S. equities. The fundamental backdrop remains challenged." I continue to think that a cautious approach to the broader markets is wise policy right now
In important news, baseball is off to a rocking start and as of today my Orioles are still undefeated. Tonight we send Ubaldo “who knows” Jimenez out to the mound, and hopefully we get good Ubaldo and not double-digit ERA Jimenez on the mound. A solid year from him would greatly increase our chance of competing for the division title. Colorado short stop Trevor Story has hit four homers in his first three games, and the young talent on the field this year is spectacular. The Padres have not scored a run yet and look to be as bad as I expected. There are some great match ups this weekend including the Orioles and the Rays, as well as the first Giants-Dodgers blood feud of the year, so I am looking forward to a weekend full of crunching numbers and watching baseball this weekend.
Tim
Let's be careful out there, lest it all turn into this.
In honor of the late great Merle Haggard.
