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
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
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