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One of the most difficult struggles we face as investors is a struggle with ourselves. Our emotions are predisposed to believe in what we want to become a reality. I face this issue personally almost every day. If I like a company or I'm long a particular stock, I'll find a reason to justify my bias, even if my original thesis doesn't hold. There are so many metrics through which investors can value and measure a stock, it's almost impossible not to find a statistic that justifies your belief. This seems to be particularly true for value investors, who look for measures to find cheap stocks.
I bring this up because M&T Bank's (NYSE: MTB ) take-under of Wilmington Trust (NYSE: WL ) on Monday highlights exactly why I won't touch real estate-heavy financial stocks with a 30-foot pole, even though many are cheap by traditional valuation metrics. The consensus Wall Street analyst price target for Wilmington Trust was $10.31. Yet the company agreed to sell itself for $3.84, a 46% discount to its closing price of $7.11 on Friday.
One popular measure of valuing a bank is the price-to-tangible-book ratio, which measures the price-to-book ratio, and subtracts out intangible assets like brand value or goodwill. For a bank this is a better measure of seeing the value of what is on its book. However, the problem with this metric for many financial companies like Wilmington Trust is no one really knows what exactly the value is of these "assets" on the book.
Does cheap mean buy?
I ran a screen to see just how "cheap" stocks had become in the banking and financial sector, using Fool analyst and financial guru Anand Chokkavelu's sanity check on valuation, which looks for banks below a 1.5 price-to-tangible book value. The screen found 43 banking or diversified financials in the S&P 500. Of these companies, 18 of them had a price-to-tangible book below 1.5. The five banks with the lowest levels are listed below.
|Marshall & Ilsley (NYSE: MI )||0.54|
|Bank of America (NYSE: BAC )||0.91|
|Citigroup (NYSE: C )||0.94|
|KeyCorp (NYSE: KEY )||0.97|
|Regions Financial (NYSE: RF )||1.01|
Source: Capital IQ, a division of Standard & Poor's, as of Nov. 1.
So if you think that financials below the 1.5 threshold are cheap, buy away, go crazy! You can also find other financial bellwethers like JPMorgan Chase and Goldman Sachs below that "cheap" threshold.
Wilmington Trust wasn't considered cheap on Friday, trading at 1.84 times tangible book value. However, its $3.84 sale price is just below tangible book value of $3.86, and apparently not even Wilmington Trust CEO Donald Foley knows who got the better of the deal.
Foley said, "There is no significant economic or real estate recovery on the horizon in our markets. Therefore, we have little assurance that our loan portfolio will strengthen significantly in the near term, or that our capital position will not erode further. These risks increase the possibility of downgrades by the credit rating agencies or adverse regulatory actions, which could compromise our businesses."
With banks look at more than the book
I recently wrote about the foreclosure mess, and the potential effects it may have on the balance sheets of banks with substantial exposure to real estate. Wilmington Trust may not have had "robo-signing" issues, but clearly there were significant problems related to the company's real estate loan portfolio that even the CEO couldn't figure out.
The point is anyone can find numbers to make a stock look cheap. Good investors dig deeper to find why a stock is cheap and if it can get cheaper. The five "cheap" companies listed above all have significant exposure to real estate in their portfolios, which may be why the stocks made the list. No one knows exactly when real estate will bottom or when foreclosures will subside, which means that no one can really place a true value on what these loan portfolios are worth.
I'll leave predictions of a real estate turnaround to commentators who are much smarter than I. But until the turn comes, there are too many other companies with strong, legible balance sheets to invest in, even if they trade above tangible book value.