Comparing Banks

[npg]

How does one determine whether WB or USB is a bank that produces superior returns?

One may instinctively point to the ROE, but that may be misleading since it does not paint the full picture. You want a quick metric that shows how efficient they are in producing returns from the money borrowed.

Enter ROA (Return on Assets).

If you look at this figure to compare banks then some of Mr Buffetts choices become quite clear.

Although it is quite hard to unpick a financial institutions balance sheet, one can use simple metrics to compare amongst peers. At current valuations banks become and interesting way to play the current recession and credit crunch. This is only safe when investing in the top dogs. The ROA can help you find out who they are. It's a very common metric that most screeners support.

Also note that the yield of many banks like USB is now almost and in some cases higher than 7%. Of course a dividend is never safe, however a solid bank with a great track record in that area will most likely keep the dividend if it can help it. Such high yield sweetens the wait.

Banks are expected to remain unpopular during economic downturns. Finding one or two excellent banks may provide a nice opportunity in building a solid position or two over the coming couple of years, ready for the recovery.

Happy hunting!

[petekoch]

I may not be exactly right about this, but I believe that USB has doubled its dividend over the past decade. Its ROA is near the top of its sector, if not the top.

The Price/Book for USB is higher than it is for most banks, but that's probably due to the fact that almost half of revenues are from non-banking related fees.

I picked up a little more USB yesterday. Yield now at 6%. I was also busy buying more USG (as in Sheetrock) under $31.

[joshuat]

Very timely, npg, I've been turning my attention from NG to banks in the last few days.

Do you have any specific case to make for WFC vs USB? USB looks quite attractive, but then WFC has just had it's share prices hammered in the last few months.

ROA only works if you are comparing banks with similar business models. There are banks that do not focus on lending as a source of income, and thus require less assets. As a consequence, they will have a lower ROA. This does not mean they are a worse investment. I know that Buffett hammers on ROA in his yearly letters, but for some banks it is not the whole story.

[npg]

I like both, USB vs WFC. Another few to consider are AIB and IRE (if you feel you need to hedge against the demise of the dollar).

WFC truly impressed me. Now that I am doing business in the US I decided to bank with them. Their services are outstanding. I will use their brokerage account as well. Their customer service is second to none. I am very happy being a silent partner in such an outstanding operation. Every day the share price drops I rejoice at another discount to a great business.

I don't have that much first hand experience with USB. That bank produces some outstanding returns though and it is said it is one of the most profitable in the business. Current prices give a very nice yield indeed. Its dividend is likely to remain intact. Current yield makes it a very attractive buy (just that divi alone makes it attractive already). However I feel that it may still be available at further discounts. I am still waiting for that one to come in a little more...

Both these stocks approach a PE that are historically their lowest in their 10 year history (USB, not quite rock bottom yet, WFC pretty much is). I felt that WFC is more value for money at this point in time and am still monitoring USB for a better opportunity.

You need to do your own due dilligence with AIB and IRE (IRE is almost like buying shares in the Federal Reserve, but in Ireland). Both are a very good play on the Euro. Both produce nice returns. Much better than British banks like BCS or LYG.

Either way, USB and WFC are getting increasingy cheaper and its almost a no-brainer seeing that these are great banks selling at nice discounts. I am prepared to double down with these two, I am not prepared to do it with lesser businesses. Increasingly I am becoming quality obsessed when investing in companies. I want the best in their sector. In todays climate we have an amazing opportunity picking up stocks like PFE or WMT at rock bottom prices (both are expected to fare increasingly well during the coming years). There is no need to dig out some obscure company because the quality businesses are not on sale. Ironically the reverse is true today. Aren't we lucky?

I would say that at the right price, both banks should be in someones portfolio. If past and current profitability are the only metrics, then I would chose USB over WFC. If moat is the the metric most important then I would pick WFC over USB.

The situation is a bit like deciding to sleep with one of two extraordinarily good looking women. I'd be promiscuous and go to bed with both

PS: Look mum, AXP has gone cheaper too!

I looooooove recessions.

[joshuat]

I hear what you are saying re quality. I've been doing a lot of bottom feeding lately, and while some of that has turned out while, other, not so much. I'm pleased to see your reference to IRE, I've done quite well on that one, especially after the recent, banking scare in Ireland ,though I am not currently invested in it due to freeing up funds for a special situation.

But I spend a lot of time combing for those special situations. I'm up 25% on the one just mentioned, which is great for a 1 month return, but where is the next one coming from? dunno. While the returns might not be quite as good with the stocks, this is a fire sale where you can buy and put the shares out of your thoughts for the next ten years. Sounds better than my daily grind.

[npg]

Indeed. My main motivation is to find companies suitable for investing over long periods, 10 years minimum. The initial discount acts as some sort of leverage over the regular returns. As the returns compound, that leverage turns out to have a substantial effect on my investment. I treat my brokerage account like a savings account --with higher interest rates.

That's all I have time for. I leave to truffle hunt to Buffett & Co.

[joshuat]

Another thing about banks - you can't read their balance sheets and interpret their risk position. All you can do is vote on management - best of breed. Even that will backfire - look at the BAC buying Countrywide debacle. Gotta wonder what Buffett thought when he heard about that. I would have been inventing new swear words.

[joshuat]

npg, here is an interesting article on bank valuations by a pretty smart guy, Pzena. Of course, he is currently in a blood bath since he has bet so heavily in financials, but what value investor hasn't seen shares they bought go down further. Anyway, he explains how banks have structured their morgage loans, and how to evaluate the probable long term outcome of the current crisis.

http://webreprints.djreprints.com/1859451386521.pdf

[joshuat]

Sir, you are using leverage.

A great quote from a Mark Sellers article in the Financial Times on rational investing. His point: if you buy a stock that is leveraged (the company has debt), you are using margin, even in a no margin account. A typical bank is leveraged 10:1, if your portfolio is 10% this stock, your margin leverage is 2:1 based on this stock alone.

The problem is when you have leverage, you are paying the interest and know what the cost/benefits are. With banks, you are not marked to market, and won't see the downside until the losses are too big to hide.

It's a sound point that I hadn't really thought out before.


Full article here (requires free subscription to view): FT.com / Columnists / Inside Curve - Mark Sellers: Rational investors should rejoice

[tropical]

Here’s a link, which may interest those eying up the distressed financials. I found it while trying to get my head (vaguely!) around the situation:

Robert Explains Financial Institution Valuation at Joe Ponzio's F Wall Street Blog

I know npg is reviewing the wreckage and has some knowledge of write down procedure from the inside. The article left me fairly sure that my head may at times be big, but that I won’t be getting it around the sub prime/bank situation in any meaningful quantative way.