Drip
Portfolio Report
Monday, March 16, 1998
by Dale Wettlaufer
[email protected]
ALEXANDRIA, VA (March 16, 1998) -- The banking and financial services industries have provided excellent returns to investors over the last fifteen years. Since the bottom of the S&L crisis and the last lesser-developed country (LDC) debt crisis, returns for the banks have been doubly impressive. A couple of reasons why this happened: 1) When you buy something at a depressed valuation and the company eventually returns to a normal valuation, that can account for a good deal of return even before growth in earnings. 2) Growth in earnings. If you buy something at a depressed P/E on a depressed earnings base, return is magnified:
Year 1 -- Stock is selling at a P/E of 7 on an earnings base of $1.00 per share when normal earnings power is $1.75 per share. Price = $7.00
Year 5 -- Stock is selling at P/E of 12 after five years of 15% earnings growth off normal earnings base of $1.75 = $3.52 x 12 = $42.24
Year 8 -- EPS growth has normalized to 10% per year, but stock market valuations are such that good quality banks are selling at 16 times earnings. EPS of $4.68 x 16 = $74.96
A stock following such a chain of events would have seen compounded annual return to shareholders of 34.5% over the last eight years. In fact, this is exactly the sort of scenario that shareholders of Citicorp (NYSE: CCI) and Wells Fargo (NYSE: WFC) have seen. Because certain shareholders saw through the doom and gloom of the defense scaleback, LDC debt crisis, S&L crisis, and real estate fallout of the late '80s and early '90s, they have been the recipients of extraordinary returns on their investments.
Developing a framework for analyzing banks and certain financial services companies is the goal of the exercise we are now entering. As someone who has taught himself how to fish in this sector, I would like to pass on some of the things I've learned. I am FAR from through learning about evaluating financial services companies and I believe that I will pick up some more knowledge along the way as a good deal of people read this study and send in comments. I will certainly share those comments with you. Anyway, the point is to get you to learn how to fish for the rest of your lifetime.
Looking at the financial statements of these companies is a daunting prospect for the uninitiated. First, let me make it clear that earnings matter and cash flow matters with financial companies. A while back when I wrote negatively about Green Tree Financial Corp. (NYSE: GNT), which blew up last year and whose management was saying some things I believed to be disingenuous, I recieved some mail that claimed that cash flows don't matter for financial companies. To the contrary, I would reply, cash flows matter as much to a financial services company as they matter to any other company. In the case of cash flows, we need to be able to make a distinction between returns of investment, returns on investment, and changes in working capital and investments. We'll work on those terms tomorrow and also lay out an outline for where we're going over the coming months.
Some housekeeping notes. YES! We will be looking at Norwest Corp. (NYSE: NOB). We'll also be looking at another fine Minneapolis-based bank, U.S. Bancorp (NYSE: USB), which used to be First Bank Systems but took the name of Portland-Oregon-based U.S. Bancorp when the two merged last year. We will also look at Fannie Mae (NYSE: FNM), since the company's financials fit into the mold of a bank's financials. Regions Financial (Nasdaq: RGBK) is one that many of you asked about, and I'm glad to say that we will take a look at the company. I worked up the financials this weekend and liked what I saw initially, looking at about 70 data points on it.
We may take a look at companies such as Travelers (NYSE: TRV) and Transamerica Corp. (NYSE: TA). That will depend as much on time as it will on the needs of Fools to be helped with looking at these companies. Some mentioned T. Rowe Price (Nasdaq: TROW) as a potential candidate, but the company's financials are so straightforward that I think there are many people who don't need help looking at the company. We also won't look at J.P. Morgan (NYSE: JPM). If you're interested, check out this article I wrote on it about a month ago. That article pretty much encapsulates my thoughts on J.P. Morgan. Selena Maranjian (TMF Selena) was also kind enough to send me this link http://www.jpmorgan.com/CorpInfo/FinancialInformation/IR/Index.html to information on J.P. Morgan's DRIP program.
We will be looking at Merrill Lynch (NYSE: MER) and American Express (NYSE: AXP), because I regard both of those companies as something that the larger banks in the U.S. aspire to be. Essentially, I see these companies as very successful banks without the hassle of being regulated depository institutions. I will not be dealing with Chase Manhattan (NYSE: CMB) because I hope that you will be able to look at the company alone when we're through and because I just don't believe it to be a superior company. I don't mean that in a bad sense, but if you want a global franchise company that does extraordinary things, I recommend studying Citicorp before looking at Chase. We will be examining Citicorp, by the way.
I've deleted a few firms from the list, including First Empire State Corp. (NYSE: FES), which is a bank that is based in my hometown of Buffalo, New York. I wrote about the company last year when it announced its acquisition of OnBanCorp (Nasdaq: ONBK), which extended the market share franchise of First Empire's M&T Bank into the Syracuse area and other markets in central New York. For non-DRIPers, I recommend taking a look at this company, which has been ably guided by Chairman and CEO Bob Wilmers. Unfortunately, we won't include the company because of its fees on the DRIP program. I can't begrudge the low-cost motivations of that decision by First Empire. We also won't be looking at State Street Corp. (NYSE: STT), a great company in Boston that is more an asset manager, securities custodian, and back-office operation than it is a bank. A great company, but I've heard its DRIP fees are brutal.
So, I'll be back tomorrow with the outline for our journey. In the meantime, Fool on!
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