Most retail investors don't follow the banking sector too closely, aside from some of the main money-center banks like Wells Fargo and Bank of America. That's OK, of course. The sector doesn't exactly offer the same thrill as others and has taken many years to recover from the Great Recession in 2008. But there are many opportunities, considering there are more than 4,800 banks in the U.S., about 600 of which are publicly traded. A hidden gem within the banking industry is the Hingham Institution for Savings (HIFS 0.20%), a small $3.4 billion asset bank headquartered in Hingham, Massachusetts. You may have never heard of Hingham, but the stock has generated more than a 6,000% return for investors since going public in 1988.
A very simple business
In the U.S., banking is a very competitive business. Some people even liken the sector to a commodity business because certain products can be so similar from bank to bank, and most bank stocks can move together through the cycle.
To stand out as a bank, many have tried to offer unique services or cater to niche industries. You'll notice that many small banks have embarked on banking-as-a-service strategies in which they essentially provide the financial plumbing so non-banks can offer their customers financial services.
But on the surface, Hingham looks like your standard bank offering typical financial services such as commercial and residential real estate lending and various depository products. Hingham has a few sectors it specializes in, including government and nonprofit banking. It also has a section on its website for start-up banking -- a sector growing in popularity -- and a specialized deposit group focused on creating a digital experience with virtually no fees for its largest clients.
Interestingly, if you look at Hingham's annual slide presentation, it has a slide labeled "What We Don't Do." Among things the bank doesn't do are commercial and industrial lending, consumer lending, wealth and investment management, and insurance. Many banks do these activities to diversify revenue further, but Hingham really just sticks to the basics. The thing is, they do these basics better than just about anyone. If banks were a group of athletes, Hingham would be an all-star.
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Outstanding efficiency
A key metric bank investors watch is the efficiency ratio, which measures a bank's total expenses expressed as a percentage of total revenue. So, lower is better. If a bank has an efficiency ratio of 60%, that means that for every $0.60 they spend, they earn $1 of revenue. It varies by asset size and business model, but generally, most investors would tell you that a sub-60% efficiency ratio is pretty good.
In 2021, Hingham's efficiency ratio was an incredible 21.3%. That is simply remarkable, and I really don't know any bank that does it better than that. That's also an improvement from the 25.4% efficiency ratio Hingham reported in 2020. It is also impressive that Hingham managed to improve efficiency in 2021 as most banks faced rising costs due to factors like wage inflation. In 2021, operating expenses at the bank only increased about 0.4%. Meanwhile, total revenue grew by nearly 25%.
Any banker will tell you that when you grow revenues faster than expenses -- therefore, creating operating leverage -- good things happen. Management is also razor-focused on continuing to manage expenses tightly. In its recent annual report, Robert and Patrick Gaughen, the family that runs the bank, wrote that "eliminating waste remains a core strategic objective of the Bank."
In 2021, Hingham generated a 2.25% return on assets (ROA), which shows how well the bank used assets to generate a profit. In banking, a 1% ROA is usually considered strong. Hingham also generated a 20.6% return on average equity. Both of these numbers are phenomenal, especially for a bank so small. As a result, Hingham has been able to return capital to shareholders through a special dividend in each of the last five years.
The bank's strong, consistent returns, coupled with pristine credit quality over the years, have led to a premium valuation. Recently, the bank traded at 223% its tangible book value, which essentially measures a bank's net worth.
Buying excellence
Although Hingham stock isn't cheap, you are buying excellence. The bank has grown book value at a compounded annual growth rate of more than 16% over the last five years. Because banks trade relative to their book value, this is a sign of tremendous value creation. Hingham doesn't necessarily do anything particularly flashy, but it relentlessly manages expenses and runs its core banking operations better than just about anyone else. This is why Hingham Institution for Savings is a hidden gem in the stock market.
