Over the past 10 years you might have grown weary of hearing about banks. There was the whole financial crisis thing, during which bank stocks fell across the board. Then there were (and still are!) scandals, ethical breaches, and generally bad behavior.
So if you're exhausted by the whole thing, I can't blame you. It's been an ugly time for the entire industry.
But that doesn't mean there aren't outliers. In fact, there's one bank in particular you should know about. This bank returned over 15% on equity last year, along with return on assets over 2%. The stock is up 359% over the past five years. Total assets have more than doubled over the same period.
That bank is the Bank of the Ozarks (OZK 4.74%), and it's showing no signs of slowing.
The blueprint for success
Demonstrating exactly how Bank of the Ozarks can put up these ridiculous numbers is simple. I'll break it down step by step.
Step 1: Exceptional fundamentals
In banking, the name of the game is making good loans that will be repaid. Sadly, the majority of the industry is not great at this. Banks tend to get greedy when the economy is hot and lose their credit quality discipline. That leads to big losses when the economy cools and marginal loans aren't repaid.
Bank of the Ozarks has exceptional credit discipline. The bank charged off just over $5 million in bad loans in the first quarter. For a bank with over $8 billion in total assets, that is remarkable. Past due loans and nonperforming assets are also well below industry averages. Credit quality is clearly a top priority.
Once a bank has risk management down pat, it next must control expenses. The efficiency ratio is the best tool for assessing that area. Having a lower cost structure means the bank can take on less risk to achieve its profit targets. Lower-risk loans come with lower yields, which for an inefficient bank would mean lower profits. However, very low costs enable the institution to focus on funding the very best loans with competitive prices and still profit handsomely. Efficiency and credit quality, in this way, kind of go hand in hand.
Bank of the Ozarks reported an efficiency ratio of 41% in the first quarter of this year. The lower the ratio, the more efficiently a bank operates.
For context, Wells Fargo (WFC 2.73%) reported an efficiency ratio of 58.8% and US Bancorp (USB -0.20%) reported 54.3%. Bank of the Ozarks is about as efficient as it gets.
Step 2: Translate that performance into a premium stock price
When a bank's fundamentals are that good, it is bound to produce top-tier profits and returns on equity and assets. Bank of the Ozarks certainly does that.
That performance will drive the stock price higher not just in step with your profit growth, but also in relative terms to a business's peers. For banks, we typical use the price-to-book value ratio to measure this. Today, the majority of the industry trades between one and two times book value, with the better-performing banks trading closer to two times.
Bank of the Ozarks trades today at 3.2 times book value. Wells Fargo fetches just 1.7 times book value. US Bancorp trades at two times. Wells and US Bancorp are two of the most respected and highly valued banks in the U.S., and Bank of the Ozarks commands a 50%-100% premium over their relative values.
Step 3: Use that premium stock price to grow through smart acquisitions
A high stock price offers a great advantage in the merger-and-acquisitions markets.
The idea is to use stock to pay for the acquisition. Because the stock is so highly valued, if it maintains that premium then the buyer simply paid a fair price. But if the stock price declines, so then does the effective price paid for the acquisition. In other words, the purchase price drops to a nice discount.
Likewise, if the buyer issues new shares in the transaction, then the dilutive effect on existing stockholders is minimized because it will take fewer shares to raise a given dollar amount.
The math just makes sense. A premium stock price offers lot of bang for the buck.
Bank of the Ozarks recognizes this, and has fueled its growth with a steady pipeline of acquisitions. This month the bank announced the purchase of Bank of the Carolinas in an all-stock transaction.
In February, the bank completed the all-stock acquisition of Intervest Bancshares. The Intervest acquisition followed deals for BancShares Inc. and Summit Bancorp, both completed in 2014. The list goes on and on from there.
It's been a buying bonanza, and it's all possible thanks to Bank of the Ozarks' premium stock price.
A great company on an amazing run
Bank of the Ozarks has done an incredible job over the past 10 years. Its stock barely registered a blip during the financial crisis and Great Recession. How many other companies can say that?
For investors today, the stock might be a bit expensive. However, if you're the type to buy the best companies and own them for the long term, it's hard not to take a good long look at Bank of the Ozarks, even at such a premium valuation.
