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How much would you pay for the shares of a business that dominates its industry and is extremely profitable? What if I told you that you can buy such shares today for less than one time book value and less than nine times estimated 2011 earnings?

Here are a few numbers on the company that should whet your appetite: In its retail business, it has nearly 40% U.S. market share. In one of its professional businesses, it has a 16% global market share. Over the past 12 months, the company earned over $28 billion, more than ExxonMobil -- which trades at nearly two and a half times its book value.

The company's name is ...
If this sounds too good to be true, it is: There is no single company with those numbers. Not to worry, though, because you can still own it in your portfolio by buying a basket of shares of the four largest U.S. commercial banks: Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , JPMorgan Chase (NYSE: JPM  ) , and Wells Fargo (NYSE: WFC  ) . I call this group the "Trust."

Now I know what you're thinking: "Sure, it looks like you can buy the Trust for less than one time book value, but bank balance sheets are a black box. Who knows what the true book values and book multiples are?" Investors certainly learned that lesson the hard way during the credit crisis, and class is still in session.

Bank balance sheets -- the gifts that keep on taking away
Last month, a number of high-profile investors (including the Fed bank of New York) banded together to try to get Bank of America to repurchase poorly performing mortgages packaged into $47 billion of securities by its Countrywide Financial unit. And B of A isn't alone: A congressional panel report dated Nov. 16 estimates total banking industry losses related to these "mortgage put-backs" at $52 billion, with the Trust making up the lion's share of the losses (B of A and JPMorgan alone represent half of the total).

Who wants to own shares with that kind of exposure attached to them? That's exactly the attitude that can create opportunity for thoughtful, patient investors. Instead of relegating the Trust to the "too hard" pile, let's take a stab together at quantifying how this latest incarnation of the credit/housing bubble affects the price tag of these shares.

Getting down to brass tacks
These are my assumptions:

  • In my base case, the Trust incurs $40 billion in losses on mortgage put-backs, 80% of the $52 billion estimate of industry losses from the congressional panel report.
  • In my extreme case, the Trust incurs $120 billion losses, three times the base case amount and one of highest estimates out there.
  • In each scenario, the total loss figure is apportioned to each of the four banks in proportion to the amounts they have reserved for mortgage repurchases at the end of the third quarter. This assumption has no effect with regard to the Trust as a whole, but it allows us to look at the loss impact on each bank individually.

If the Trust were to write down the entire amount of these losses today, this is how it would affect current price-to-book value ratios:


Price/Book Value*

Price/Book Value

Adjusted for Base Case Mortgage Losses*

Price/Book Value

Adjusted for Extreme Case Mortgage Losses*

Bank of America 0.52 0.54 0.66
Citigroup 0.73 0.74 0.78
JPMorgan Chase 0.89 0.93 1.11
Wells Fargo 1.21 1.23 1.36
TRUST BASKET* 0.86 0.88 1.01

*At Nov. 23. The basket is weighted by float-adjusted market capitalization; however, the multiples for an equal-weighted basket are virtually identical. Source: Author's calculations based on data from company financial reports and from Capital IQ, a division of Standard & Poor's.

If you can't touch it, don't count it
The table confirms that, even under our extreme scenario, you can buy the Trust at one time book value. Still skeptical about bank book values? So was I, so I performed the same calculations with the price-to-tangible-book-value multiples. Tangible book value excludes intangible assets, which are neither physical assets nor financial assets; the main intangible asset is goodwill, which is the product of acquisitions.

The Trust's current price-to-tangible-book-value multiple is 1.25. Base case losses result in a multiple of 1.30; under the extreme scenario, it rises to 1.63. Both can be justified on very reasonable growth assumptions. If we take the base case multiple of 1.30, and assume the Trust earns a 14% return on tangible common equity against a 12% cost of equity and pays out 40% of its earnings in dividends -- all conservative assumptions -- then 8% earnings growth will do the trick.

A trade with an unobstructed path to profitability
After a huge rally off the March 2009 lows, I believe investors are stuck looking in the rear-view mirror, focusing on the "easy" profits in large-cap bank shares they woulda/coulda/shoulda made, to the exclusion of those they can still make. Not to mention that the risk profile of the trade is very different from what it was in March 2009: Putting it on no longer requires an iron stomach, and its upside is not clouded by massive uncertainty. Investors who combine these four stocks in their portfolio today are likely to earn premium returns from the Trust over the next three to five years and beyond. Warren Buffett believes that's the case for the Trust stock with the highest book value multiples, Wells Fargo, as he added 16 million of its shares to Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) already massive stake during the third quarter.

If you'd like more investment ideas -- ones that the Fool is backing with its own money -- simply request our free report 5 Stocks The Motley Fool Owns -- and You Should, Too.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. The Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (41)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 24, 2010, at 4:00 PM, dfrizzle03 wrote:

    i don't disagree with the article. i just think you're a little crazy for putting Citi on that list.

  • Report this Comment On November 24, 2010, at 6:22 PM, MegaEurope wrote:

    "There is no single company with those numbers."

    What if I told you that you can buy Gazprom shares today for less than .7x book value and less than 4x estimated 2011 earnings?

    Over the past 12 months, the company earned over $31 billion.

    This natural gas utility has nearly 100% Russian market share and 25% European market share. It makes up 10% of Russia's gross domestic product.

    In natural gas production, it has a 17% global market share.

  • Report this Comment On November 24, 2010, at 7:09 PM, TMFAleph1 wrote:


    Nice catch! I hadn't thought of Gazprom. Ironically, I pointed just how cheap its shares are at the end of July:

    This Energy Major is Cheaper Than BP

    Jul. 30, 2010


    Alex D

  • Report this Comment On November 25, 2010, at 2:54 AM, polenium wrote:

    Are you kidding? sThese banks still have hundreds of billions of bad debt on their books that won't go away anytime soon.

    It Congress or the newly formed Comsumer Protections Agency stops them from stealing homes, some of them will be forced to shut their doors. (B of A).

    Unless you have a trillion so laying around to bail them out, back away from the "trust". Who thought up that name anyway, George Orwell?

  • Report this Comment On November 25, 2010, at 4:48 AM, edvale wrote:

    I don't get the P/E ratio - Citi and BoA are zero, the other two 17 and 11?

    Nor are their problems restricted to mortgage lending - in my ignorant view. Also, I see political interference ahead should they start making decent returns.

  • Report this Comment On November 25, 2010, at 6:38 AM, TMFAleph1 wrote:

    <<It Congress or the newly formed Comsumer Protections Agency stops them from stealing homes, some of them will be forced to shut their doors. (B of A).>>

    Not sure what poor quality sources you are relying on, but (a.) foreclosing on homes on which the owners have stopped making mortgage payments isn't stealing them, it's perfectly legal; and (b) B of A is at no risk whatsoever of being shut down by the authorities.

    TRUST noun \ˈtrəst\

    3 b : a combination of firms or corporations formed by a legal agreement; especially : one that reduces or threatens to reduce competition

    Alex Dumortier

  • Report this Comment On November 25, 2010, at 6:43 AM, TMFAleph1 wrote:

    <<I don't get the P/E ratio - Citi and BoA are zero, the other two 17 and 11?>>

    The individual bank P/Es based on estimated 2011 EPS and closing prices on Nov. 23 are:

    BAC 7.60

    C 9.15

    JPM 8.08

    WFC 9.44

    Weighted by float-adjusted market capitalization, the P/E of the group is 8.54.

    Alex Dumortier

  • Report this Comment On November 25, 2010, at 5:59 PM, Momentum21 wrote:

    Interesting article...I like the thought process, thanks Alex.

  • Report this Comment On November 25, 2010, at 6:00 PM, Momentum21 wrote:

    Interesting and I like your analysis/thought process here...thanks Alex

  • Report this Comment On November 26, 2010, at 6:42 AM, TopAustrianFool wrote:

    You are asking for trouble if you put your money in Banks. They are so highly regulated and so influential with govt there is no way you can have enough transparency in order to understand their business.

    Talk about having a short memory...

  • Report this Comment On November 30, 2010, at 12:04 PM, ikkyu2 wrote:

    Who the heck needs transparency? What's transparent is that these companies are too big to fail and that the US Government will backstop them by any means necessary.

  • Report this Comment On December 22, 2010, at 7:26 AM, TopAustrianFool wrote:

    "Who the heck needs transparency? What's transparent is that these companies are too big to fail and that the US Government will backstop them by any means necessary."

    So, you won't loose your money, but won't make any either. So good look beating the 10%/yr inflation the Fed is racking up.

  • Report this Comment On February 10, 2011, at 10:34 PM, stockmajor wrote:

    Yes, bank accounting is and will be smoke and mirrors for some time to come, but that is exactly what makes them good investments.

    Uncle Sam gave the banks a get out of jail free card and the intent is to allow them to slowly work the bad assets off their balance sheets and allow them to return to normal operating profitability. Note the zero interest rate policy and yield spread gift to the banks from their beneficent uncle.

    I think Uncle Sam has been making the right moves with TARP and mark to market, etc. We couldn't allow our financial system to collapse.

    So, with our big uncle behind the banks and the game plan of making sure that they survive and thrive, the banks are just about as guaranteed an investment as one can make.

    I'm in big on Citi and Bank of America. In a couple of years you will see the balance sheets largely cleared up and the stock values should double from their current values. They may possibly be higher if stock buy backs are initiated.

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