February 7, 2011 § 4 Comments
This is also a study in: when checklists don’t work. Bum bum buuuuuuh.
So I’ve spent some time figuring out my personal checklist in order to minimize losses and hopefully teach myself some patience, wisdom and prudence. And I really like my checklist. Even just having it down on paper and being able to reference it has been a great learning experience (and has made me go “what was I thinking!” on a bunch of old positions I had.)
But there are times when a checklist breaks down. And for me, that is currently with an industry I like moving forward: small bank stocks. I’ll admit, I don’t know how to properly read bank balance sheets in order to see if they are super risky or just ok. For these reasons alone I am staying away from Citi and BOA and JP Morgan and all of the other big investment banks. They don’t have a great management track record to say the least; they don’t seem to care about making their business sustainable. Heck, they wouldn’t throw water on a burning puppy if it meant a few cents off their EPS.
But there are banks out there I do like, and I think it is an industry that is going to do really well in the future. Small banks. Narrowly focussed banks. Banks that don’t do much more than take on deposits, loan out money, do mortgages and so on (you know, things I can understand) as opposed to taking your money, hiding some toxic assets in it, calling it a Colateralized Debt Obligation and selling it to some poor schmucks, or groups of schmucks, or worse yet, pension plans (read: old people) and taking them for a ride.
One of the banks I’m looking at (and will be adding to CAPS) is a bank that has been getting tanked recently and is near their 52-week low (which is usually a trigger for me to look into them.)
But like I said: my checklist doesn’t accommodate banks. Banks don’t have inventories. You can’t really do a NCAV or a NNWC screen on em. I don’t even know if calculating their CROIC even means what I think it means!
But let’s look at reasons why I do like em:
1. CROIC (if it even works) is sitting around 7%. Not great. But when I do a DCF using 80% of CROIC as the growth rate, I get a value of about $20/share. It’s sitting at $11.17.
2. P/E of around 10 confirms the potential cheapness of it
3. Management is awesome. They didn’t go for all the craziness of the housing boom. They in fact shunned the “cheap” growth they could have got by altering their underwriting standards. That means they didn’t take on NINJA loans (No Income No Job or Assets). They hoarded cash during the boom and managed to keep their dividend secure during the crisis. That to me is stunning.
4. The dividend. 5.5% with a payout ratio at around 50%. That payout ratio is high, but I am confident management can hold it together.
5. Have an above 6 in Piotroski Score (but I’m unsure if that is helpful for banks)
6. Look to be growing, and are in a sector I like.
7. Probably aren’t evil.
Reasons I don’t like them:
1. I don’t know the industry all that well, and definitely not well enough to spot problems before they are baked into the price
2. Dividend cut could happen
3. Are in a competitive industry and when big banks recover, they could dilute the potency of the small banks.
4. The margin of safety may not be high enough. The Graham Intrinsic Value Discount has a pretty thin margin of safety, while the DCF is just under 50%.
All that being said, I put the intrinsic value of the bank around $20. Add in to that the 5.5% divided and I will probably buy it if it goes south of $11 again. Heck, the good management alone is enough for me to want in. I’m cool with paying a fair price for a stellar company. But since this bank looks a little (not a lot) cheap, plus that dividend as an added margin of safety…well.
Hit up your thoughts in the comments.
February 4, 2011 § Leave a comment
One of the things that I find really fascinating and also hilarious (and, if thought about too much, super scary) is when 24-hour news stations have nothing to report on, so they try to find some interesting new story that in reality isn’t all that interesting and actually not really new. But they find it anyway and put it up with the crazy fast moving news graphic. And then they have that expert—-who has apparently dedicated his entire life to the study of this particular story—-flown in to put it all into perspective for us. (The one that made me realize that this was bonkers was when I was doing my MA in Theology and CNN had this week long news story on the fact that there are more than 4 gospels written and one was even about Judas being a good guy! And it was this big crazy deal! The end of the Bible! Except for the fact that any MA student in theology, antiquity, medieval history or religious studies has read all of these much later gnostic gospels and this is, in fact, not new or news. Oh well.)
Now, this isn’t to put down 24 hour news networks. I’m sure there is some benefit to them and we may figure out that benefit one day. But this all-too-common occurrence has significance for the value investor. That significance is that our society places an exorbitant amount of value on the specialist—-the dude who’s spent years of his life studying the significance of some minute cross-section of human understanding, in order to increase our collective understanding of that thing. And these specialists are super important: I come from a family of PhD’s and I’ve seen both the dedication needed and rewards for being the expert in a field. (In fact here is a cool lil cartoon about why PhD’s are totally necessary.) But in placing so much weight on the word of the specialist, we set up a value-drawing mechanism that is silly when you actually sit and think about it. Or to put it in another way, when we place so much weight on the authority of specialists, something else is smuggled in that I don’t think we actually want. And that thing is an attitude and a belief system that I think the true value investor needs to shy away from and be comfortable in dismissing.
So what is that thing? Well, it is the belief that the more detailed you can get in your data, the more precise you can be in your conclusions and therefore you’ll make better decisions.
On the outset the correlation between data and precision seems to be pretty linear. More data = better decisions. Only a fool would jump in his car with 30 min before his flight on a 20 min drive to the airport without looking at the traffic report. If you know one route is slower, you take the other one.
But this reasoning does not continue ad infinitum. There comes that point on the spectrum where the data begins to be irrelevant, a time-suck or so small in significance that it doesn’t affect the situation. Accumulating this data is meaningless and wont (or, perhaps, shouldn’t) alter your decision and may make you screw up the whole process. Just because you’ve spent 30 min figuring something out, it doesn’t make it any more right or wrong or authoritative than the thing you figured out in 30 seconds.
Now we generally act with common sense in our everyday lives. No one, upon seeing that route A to the airport is bumper to bumper, collects data about their car’s fuel efficiency ratios regarding route B. Route B may be longer or more hilly or the escarpment may cause a wind-tunnel effect drag on your vehicle, but route A will cause you to miss your flight. We filter out the little details with the big trump.
But for whatever reason, we don’t do this with the market. My guess is because when we were kids we were told a lot about chaos system and all watched the little cartoon of the butterfly flapping his wings in some exotic country and producing a hurricane in Saskatchewan or whatever. And a lot of ink has been spilled about how that same butterfly flapping will cause Exxon Mobil’s revenue to go up 2.6%, on average for the next 10 years (adjusted for inflation.) And people make market decisions based on this stuff. And it’s crazy.
And as people lose money by doing this and as technology gets better and faster, we reason that we haven’t been beating the market because we haven’t got detailed enough. So there is now a race-to-the-bottom-of-things in order to corner the market and be able to make the proper correlations between the flapping and the ticker symbols. And people pour lots of money into faster trading platforms, or will throw money at MIT math PhD grads in hopes that these people who have dedicated their life to cutting edge probability math will, by means of their special insight, unlock the hidden mysteries of the chaotic system and you are bathed in a money shower. So you got the guy who’s an expert on butterfly flapping in the commodities sector and one in energy stocks and an expert on this circumstance and that circumstance in hopes that their combined power will somehow give you an edge. And it doesn’t work because of the misplaced correlation. More data does not equal precise conclusions.
So what is a value investor to do? Well, one thing is to get real comfortable with mystery. And what I mean by mystery is that grey zone between the seeming randomness of the incredibly tiny and the general order that we have around us. If you keep going smaller and smaller, down past the atom and all the way into the quarks and tiny half particles, physics tells us that when we get that low, everything is random movement and we can’t really figure out how all this random movement of particles holds an atom together and brings order to the world around us. Have you ever tried to have a conversation with a die-hard materialist? He’s talking about the randomness of particles and how because of this randomness we can’t really know anything for certain, except you know for certain that he’s a crappy lunch companion. There’s a gap that is too big for us to compute between the random/small and the big and predictable. There may be a correlation, but we can’t figure it out and it probably wont be a factor in the real/macro world until it is no longer small, but big and more easily discernible. In other words, don’t worry about a butterfly flapping in New Jersey. But if 65 million butterflies are flapping in New Jersey at once, I’m not taking a plane out of LaGuardia. Or, as Buffet said, look for one foot hurdles to step over, not seven foot hurdles to try to beat.
And the best way to do this is to try to increase your general knowledge of all things. Be a specialist, but don’t think that going super deep into one aspect is going to magically shed light on other things. It’s like putting a cardboard tube on the end of your flashlight. No, I think the true value investor has to be comfortable with the whole range of human experience. The best value investor is not a craftsman, perfectly sculpting a portfolio, but a great editor, cutting out the things that don’t need to be there and boiling decisions down to the essential (and statistically higher probable) elements. And don’t sweat the fact that you can’t know everything about everything. You will be far better off knowing a bit about tons of stuff rather than a lot about a small section. If anything, being a generalist will keep you safe from the man-with-a-hammer syndrome. The MWAH syndrome is that to a man with a hammer (ie: the thing he is a specialist about) every problem begins to look like a nail. (I’m looking at you Paul Krugman.) But if to you every problem is a nail, when you meet a screw you are, well, screwed. But if you can call a nail a nail and a screw a screw, you wont panic when something new and unforeseen enters into your investment life. No panic and steadiness is good. Strive for that.
So value investors should learn about as much as they can. And not just in the business world either. They should learn how metaphors illuminate aspects of human experience; they should learn about math and probability. They should learn about psychology and how people act differently in groups vs how they act on their own. They should definitely read history and primary sources from antiquity. (Basically, they should read Art of Manliness.) That well rounded, wide range of insight to draw from should be the thing we as value investors really strive to develop. Not just for making wise choices in the market, but for building up character in general and being a better man.
But as long as there are people putting all of their eggs into the specialist basket, there will be market discrepancies that should provide lots of one-foot hurdles. Happy jumping!
I am long XOM