I keep trying to lead the charge on community banks but every time I look behind me I am almost alone in the sector. Everyone is looking for a magic five minutes-a-night-swing-trading system that beats the market every week, day and hour of the year.
The biggest problem most people seem to have is the lack of liquidity in these smaller stocks. Others think the idea of holding shares of First Community Bank of Middle of Nowhere is too boring. There seems to be an almost compulsive need for excitement and action among individual investors when that is exactly the wrong approach.
I am fond of quoting Charlie Munger as he is almost as much of a curmudgeon as I am and he has far more money and success in the financial markets. He pointed out that he got rich by having a long attention span and practiced sitting-on-his-butt investing.
I call small banks the trade of the decade but in truth it is an investment, not a trade. If you are going to keep score against the indexes every day, week, quarter or even year, then this is probably not for you. That is, unless you are willing to change your mind set to improve your profits.
Although my portfolio of little banks is beating the market rather handily over just about any time frame you can mention, there will be periods of underperformance. Anyone who claims to outperform all the time under any conditions are liars. Anyone who could actually do that would never leave their house for fear of someone figuring out how they are doing it.
Owning these stocks can be boring for extended periods of time. Many of these stocks are what Louis Navellier calls bunny rabbit stocks. They tend to just sit around doing not much of anything until there is news that moves the stock. It may be a new buyback, a big earnings report, a 13D filing, a management change or a takeover offer. But it often takes a news announcement of some sort to get these stocks moving. Until you get an announcement you have to just be patient. They are not liquid, so don’t try to trade around your position
Be very aware that activists matter very much in this sector. We held shares of Naugatuck Valley Financial Corporation (NVSL) and received a takeover offer for the shares this week that is going to give us a nice gain. The stock has not done much over the past year, but I knew that both Joseph Stilwell and Lawrence Seidman had representatives on the board. One way or another, they were going to find a way to boost shareholder value.
The Sterne Agee study done by Matthew Kelly and his team last year clearly demonstrated that community bank stock with an activist presence in the stock had enormous excess returns during the activist ownership period. You need to know who the activists are and which ones have been the most successful in pushing stocks prices higher or forcing the sale of the target banks.
Smaller is better in this space. It is the banks under $500 million in total assets that will have the most problems with increasing compliance costs, expensive technology upgrades and the slow growth economy. To add fuel to the smaller bank preference, regulations just took hold that allow smaller banks with between $500 million and $1 billion in assets to take on additional debt at the holding company level. They are allowed to use the money to buy other banks, buy back stock or pay dividends.
That makes extra capital available for banks in that size range. They can use more borrowed funds, up to 75%, to buy smaller rivals and increase their asset base and branch network. The banks with $300 million and under are now more attractive takeover candidates than they were before these regulations took effect
A peek inside my bank portfolio might be instructive. I own lots of banks with more than 60 positions right now. I have no idea which ones will be taken over or when so I just own the ones that fit my criteria. I have a marked preference for the smaller stocks as my average market cap is below $40 million.
My latest buys have been under $20 million total market cap. I like to buy at 85% of book value. or less, but will occasionally pay as much as 90% for one with several activist or high performance metrics.
Almost all of my holdings have at least one activist or bank stock specialist as shareholders. Most of them have low, nonperforming assets and above average equity-to-assets ratio. Although not planned, most were once a mutual thrift. I am content to hold them forever as long as they don’t trade too close to the current takeover multiple of 1.35x book value.
I never said the trade of the decade was easy money. I just said it has the potential to make you a lot of money via a close focus on valuation, activists and insiders and the aggressive practice of sitting-on-your-butt investing.