Monthly Archive for September, 2009

Aligning Interests

Posted on September 30, 2009, 8:00 pm. 2 Comments

This past weekend I relocated to Atlanta, Georgia to begin work at my new job. I will soon be working at Banyan Capital Management primarily as a portfolio manger and analyst, but I will also be responsible for many other things.

I am very excited to be a part of Banyan as I believe Banyan is part of a very small percentage of the total wealth management services out there that truly has the client’s best interest at heart. There are a number of factors that allow a wealth management service in general to excel above all others:

  • Performs its own research and invests within its circle of competence
  • Employees must “eat their own cooking” and should not hold any security its clients do not also hold
  • Extraordinary responsiveness and service to clients; a small, non-institutional operation is best for clients
  • Fee-based service as opposed to transaction or commission-based; how is a client better served by an institutional money manager that earns a large commission for selling a “product” as opposed to the independent advisor that earns only a low fee based on assets under management?

The above factors—just the first few that came to my mind—work in concert to align the interests of management with the interests of the clients. Management should invest client money as if it were their own. Without this alignment, management has little incentive to think of the long-term. Also, there is little incentive for management to focus on absolute returns—its much easier to seek to perform well on a relative basis.

Interesting and Non-Traditional Economic Indicators

Posted on September 26, 2009, 8:52 am. 0 Comments

The Cheapskate Blog from Time.com lists ten odd economic indicators. It’s interesting to see how different groups of people react to recessions and how those reactions effect the rest of society.

The signs are everywhere. You know the economy is struggling big time when your underwear is old, the armed forces don’t need recruits, there’s a hot resale market for cemetery plots, you can’t find the local pro football game on TV, your rich neighbors are clipping coupons, and your waitress looks like Megan Fox. That is, if you’re eating out at restaurants at all.

1. Appalachian Trail Hikers. When the going gets tough, the tough take a hike. There’s been a spike in the number of hikers making the long trek—meaning plenty of people have plenty of free time on their hands.

2. Immigrants in the U.S. After rising for decades, the number of foreign-born residents has stalled. Apparently, immigrants just aren’t as attracted to this country as they once were.

…

4. The Reselling of Cemetery Plots. When people buy one of these, you gotta assume that the thought never entered their heads that one day they’d want to—or have to—sell before putting them to use. People need the money, and suddenly cremation is cool.

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7. The Toughness of Marine Ads. The Marines have met all of their recruitment goals, as typically occurs when the job market is bad. And so ads on TV are showing the toughest side of being a Marine, with barbed wire and even some dry heaving. Why? Because now they can be picky, and they want to attract the toughest, most highly motivated recruits.

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10. The Hot Waitress Index. Here’s the theory: When times are flush, attractive women in big cities have many opportunities to make money through marketing gigs, modeling, hosting parties, and such. When times are less than flush, those opportunities dry up, and then restaurateurs scoop them up to wait tables—and to attract diners who like being served by hot waitresses.

There’s actually an investment opportunity listed above. Buy cemetery plots at a discount during  a recession and resell when prices adjust upward!

Some Small Cap Bank Stocks That Have Been Listed for 20 Years

Posted on September 24, 2009, 11:37 pm. 0 Comments

Using my broker’s trading software, I performed a scan to come up with a list of small cap bank stocks from which I would further refine by only keeping those stocks that had been listed on an exchange for 20 years. My basic theory behind this is that if a bank stock has lasted for 20 years, through thick and thin and multiple economic and financial crises, then its likely that the management knows what it is doing and and has a conservative credit culture.

Here were my parameters for the scan: all stocks categorized under “Depository Institutions”; price > $5; volume < 360,000; market cap in between 49M and 6,300M; and EPS > -0.1. This search pulled up over 25 stocks, and from there I picked the stocks with trading histories of 20 years or more. Here is the end result:

smallcap-banks-long-histori

I think this is a pretty good list of small cap bank stocks with which you can launch a more in-depth investigation. Like I said before, because these stocks have been listed for 20 years or more, I think chances are good this fact signifies that the management and the credit culture of these banks are very good.

Yields on Insurance Company Stocks

Posted on September 24, 2009, 11:04 am. 0 Comments

Here is a list of the yields of the stocks of some insurance and insurance-related companies:

2009-09-24-insurance-yields

There are many insurance companies which do not pay dividends because they feel they can earn a better return on the money for their shareholders. Take for example Warren Buffett’s Berkshire Hathaway, which has never payed a dividend to shareholders.

However, there are some people out there who are comforted by the fact of a steady dividend. The stocks listed above may or may not be attractive, its just provided for those who may want to do some further research into dividend-paying stocks of the insurance industry.

Ignorance in Finance

Posted on September 23, 2009, 3:55 pm. 0 Comments

In finance, ignorance is only briefly bliss.

Looking At Nintendo

Posted on September 22, 2009, 10:47 pm. 0 Comments

Currently, the price of Nintendo shares have been trading in the low 30s, down more than half from its most recent price peak and also trading at prices not seen since early 2007.

2009-09-22-ntdoy

Right now, Nintendo has a trailing P/E of 12 and its forward P/E is 9.8, which says to me that is most likely not that expensive. Nintendo also has very good margins and returns on equity and assets.

Super Mario World title screenAs for the company itself, I am uncertain how to describe where from it gets most of its profits – is it from the sale of its hardware or is it from the sale of its software? I’m sure I could figure this out with some more research, but a good guess is that most valuable assets of Nintendo are its intellectual property and game franchises and it makes its money through selling software, not hardware. I’m pretty certain that the physical game devices produced by Sony, Nintendo, and Microsoft are often sold at cost or at a loss for many months or even years and that it is the software where these company make their money.

This is important to figure out especially when attempting to value the company using a discounted cash flow analysis. One usually attempts to find the rate at which the “owner earnings” have grown over the years and then project that into the future while discounting the future earnings to their present value. To find owner earnings, one takes the operating cash flow and then subtract the maintenance capex.

One can equate maintenance capex with depreciation and amortization, but this can sometimes provide an inaccurate result. More importantly, in regard to a company like Nintendo where I think its profits come from being able to successfully create, market, and sell new games, one should probably consider research and development and advertising expenses as part of the capital expenditures required to maintain or advance its position in the market place.

To illustrate this point a bit better, here are my estimates for Nintendo’s owner earnings for the past three years:

ntdoy-owner-earnings

The first estimate is much more generous as it only counts depreciation while the second estimate is much less generous because it factors in substantial advertising expenses and R&D. I suspect the true amount lies somewhere in between the two estimates, but definitely closer to my second estimate. If I had simply stopped after completing my first estimate and not considered whether advertising and R&D are part of Nintendo’s maintenance capex, I might have deluded myself that shares of Nintendo are trading at a steeper discount (and with a higher margin of safety) than they actually are.

In conclusion, before I even decide to think about purchasing Nintendo, I must do further investigation into how it operates as a business. Concurrently, I will have to attempt to gain a better understanding in how much its advertising and R&D should be considered as part of its maintenance capex. Also, if anyone reading this feels I am mistaken about anything in this post, please let me know by commenting.

Atlantic Southern Bank (ASFN) Gets Cease and Desist From FDIC

Posted on September 19, 2009, 12:00 am. 0 Comments

Yesterday, on Thursday September 17, 2009, Atlantic Southern Bank (ASFN) reported in an 8k filing that it entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist with the Federal Deposit Insurance Corporation and the Georgia Department of Banking and Finance.

Here are my two previous posts on Atlantic Southern:

In a meeting with the president of a small private, community bank in Georgia last week, I was told that 48% of the banks in Georgia are under some kind of order from either the FDIC and/or Georgia Department of Banking and Finance. Now we can add Atlantic Southern to that list.

This recent development confirms my suspicions regarding Atlantic Southern and I maintain my belief that chances are extremely good that Atlantic will fail sometime in the next two years unless it can raise additional capital.

Here is Atlantic Southern’s Mission Statement as copied from its web page:

Atlantic Southern Bank endeavors to be a high performance community bank, providing shareholders with a fair return on their investment and giving our communities a bank that is dedicated to improving the quality of life.

Our mission can best be accomplished by applying sound banking principles in corporate decision-making and by providing our customers a degree of highly personalized, professional service that is unmatched in the markets we serve.

It seems to me that Atlantic Southern has failed miserably. A truer Mission Statement would read as follows:

Atlantic Southern Bank is a low performance community bank, providing shareholders with a negative return on their investment and giving our communities a bank that is dedicated to improving the quality of life.

Our mission has been accomplished by applying unsound banking principles…

If I were a shareholder, I would definitely be asking managers and directors to step down and I would also be asking why since December of last year they haven’t purchased shares of the bank they claim to be so high performance. Well, I think the answer to why no insider has purchased shares at the current discounted price is pretty obvious now: the insiders have no confidence and I think the insiders knew at the beginning of this year that regulators would soon be in their offices and the insiders knew that there would eventually be a cease and desist.

Comparison of Four Banks

Posted on September 18, 2009, 6:38 pm. 0 Comments

This PDF shows the data I compiled for 4 banks, one relatively small bank and three other banks that most investors would describe as strong and well-run: Wells Fargo (WFC), US Bank (USB), and JPMorgan (JPM). Though this post has been modified to hide the identity of the relatively unknown bank, which I’ll be calling “Mystery Bank,” I thought a comparison between WFC, USB and JPM would still be valuable to those still reading the blog.

I know this is simply a relative comparison of four banks and not an analysis of each bank on an absolute basis, but I thought this might be a helpful exercise to help further acquaint myself with the relevant banking metrics. So heed this warning: this data is only the 2009 Q2 data, a mere snapshot – this is by no means a full and fair evaluation of any of the banks discussed.

So without further ado, here are my thoughts:

1) By far, WFC and USB had much better returns on their assets and equity than the other two banks. I also find it interesting that the smaller Mystery Bank had 50% better returns on equity and assets than JPM.

2) Out of the bunch, Mystery Bank seems to be acting more conservatively when it comes to credit loss provision to net charge-offs and it relatedly has a more generous earnings coverage of net loan charge-offs than the other three.

3) In regards to noncurrent loans to loans, Mystery Bank with a ratio of 1.97% is clearly better than the other three: USB with 3.75%, WFC with 5.22%, and JPM with 5.67%.

4) In regards to Tier 1 risk-based capital ratio, a measure of a bank’s financial strength from the FDIC’s point of view, Mystery Bank is clearly the best out of the three.

The FDIC describes a bank as “Well Capitalized” if the Total Risk-Based Capital Ratio equal to or greater than 10 percent, and Tier 1 Risk-Based Capital Ratio equal to or greater than 6 percent, and Tier 1 Leverage Capital Ratio equal to or greater than 5 percent. All four banks are “well capitalized,” but it seems that USB is not as well-capitalized as the other three banks.

(One question I would like to find an answer to is whether a bank can be capitalized too well and how a bank goes about finding and maintaining an appropriate capitalization level.)

5) Mystery Bank, WFC, and USB are all able to earn a yield approaching 5% on their assets while JPM is the clear laggard in this area trailing WFC by 80 basis points. However, WFC and JPM seem to be much better with their cost of funding their earning assets. So in the end, all four have fairly similar net interest margins, but WFC has the best net interest margin by about 50 basis points to the next closest bank in the group.

6) In regard to net loans and leases, Mystery Bank, WFC, and USB all have fairly similar percentages, but net loans and leases comprise only 36.5% of JPM’s assets (I guess this reflects the fact that JPM is still more an investment bank). The only thing that might worry me about any of these banks in this area (remember, speaking only in comparative terms) is that Mystery Bank has about 20% of its loans devoted to construction and commercial real estate. However, I don’t think this is something to worry about because the real problem banks and the banks that have failed are the ones that devoted upwards of 35 to 40% and beyond to construction and commercial real estate.

7) In trying to determine which of these banks might be the most undervalued in terms of share price, I think a quick and dirty way might be to figure out the price to tangible book value ratio. Here, we find that Mystery Bank is trading at its tangible book value, WFC and JPM are trading at about 2 times tangible book, and USB is trading at a high premium of 3.4 times tangible book.

Judging from just the above data for Q2′09, my gut reaction is that Mystery Bank might be the most undervalued and therefore might offer the greatest amount of safety and largest opportunity for price appreciation. Mystery Bank has a lower noncurrent loans ratio than all the others, seems to be better capitalized, has earned higher returns on equity and assets than JPM, and has a very good net interest margin considering that it definitely lacks the same efficiencies of scale as the other three banks in this comparison. Also, it appears that insiders hold a large percentage of outstanding shares, always a good sign.

So if we agree that Mystery Bank is just as good a bank as JPM or even slightly better based solely upon the metrics, and there are no unseen problems with Mystery Bank, it seems that Mystery Bank deserves to trade at a larger multiple of its tangible book value.

The biggest deterrent to purchasing shares of Mystery Bank is that its low trading volume. Despite this downside, I have read that unfollowed and illiquid stocks often have a greater potential to be undervalued and this could be to an investor’s advantage if they are confident in their analysis and have the fortitude to withstand market fluctuations.

Finally, I think WFC is potentially the second-most undervalued and definitely the strongest bank of the bunch in terms of earning potential.

Some Links for 9/17/09

Posted on September 17, 2009, 12:22 pm. 0 Comments

Here is some recent news I’ve found interesting:

Living in a Fairy Tale and Diamond Prices Post-Crash

Posted on September 15, 2009, 10:15 pm. 0 Comments

Via Bloomberg – “Diamonds Post-Lehman Have No Aura as Buffett Can’t See Recover“:

Jon Bridge, whose family has sold jewelry in Seattle for 97 years, said he grew so accustomed to rising sales that he faced more crises on the boards of charities. That changed in October, as the co-chief executive officer of Ben Bridge Jeweler choked down dinner in his home office and pored over reports showing a 20 percent decrease in sales, the most he had seen.

“This wasn’t just a bubble, this was a balloon, a hot-air- balloon explosion,” said Bridge, a great-grandson of the founder of the 75-store chain, owned since 2000 by Warren Buffett’sBerkshire Hathaway Inc.

Bridge blamed easy credit and inflated incomes for exacerbating the bust.

“We were living a fairy tale for the last 10 years or so, and you can’t do that,” Bridge said.

The chain has closed three stores in the past year. Buffett’s other jewelry-store company, North Kansas City, Missouri-based Helzberg Diamonds Shops Inc., has shut 19 stores this year, reducing its total to 233.

Buffett, 79, told Bridge employees not to expect a quick recovery. The billionaire investor, who receives a mailed copy of Ben Bridge’s weekly sales, met Bridge and other executives for lunch in May at Chandler’s Crabhouse on Lake Union, north of downtown Seattle.

“We are deeply in this — in a recession — and it’s going to take a long time to get out of it,” Buffett said over his usual meal of steak and a cherry-flavored Coke, according to Bridge. Buffett didn’t respond to e-mailed questions.

When we’ve been living in a fairy tale for the past decade, where consumer spending has been funded entirely by debt, this statement by Jon Bridge is an indication of the serious troubles still ahead of us.