Dick Bove's Apology

On CNBC this Monday, Nov. 28th, analyst Dick Bove apologized for the failure of his foremost recommendation of the year: US bank stocks.

The official apology ran like this: “I failed to understand that the fears in the market concerning banking were so great that the fundamental improvements in the economy, the industry, and companies like Bank of American and Citigroup would simply be ignored.”

In other words, Bove's "apology" consisted of telling investors that they are foolishly selling excellent stocks that are a great value, simply out of fear.  He didn't quite call them idiots, but pretty close.

The reason I mention all this is because I agree with him.

Back in March (US Banks to Rumble), and again in August (Buffett and the Beautiful Banks) and I'm sure a few times in between, The Frost Report has recommended buying US bank stocks.  But after a short-lived pop, bank stocks kept dropping.  And dropping some more.  And a bit more yet.  So what have I been doing?

Why, buying more bank stocks, of course!  Instead of trying to guess which particular bank will fare the best, I have been purchasing the KBW and XLF bank index funds.  Every time the market has a 2-4% correction I buy more, since each "correction" misprices them just a little bit more.

The view that bank stocks are a great bargain is clearly an unpopular one.  Every time someone recommends bank stocks (like Dick Bove), their article is overwhelmed with comments calling them a loser/screwball/dope/idiot, or ranting about bank bailouts and world domination.  Fortunately, my goal is to make money, not to make popular decisions.

Bank stocks will recover because they are highly profitable, and an economic necessity for which there is no replacement (contary to popular sentiment, credit unions are not equipped to handle large-scale multi-national banking).

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See also:
Bill Miller vs Instant Gratification
Bank Debt is Near Record Low

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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Buffett and the Beautiful Banks

For months now, The Frost Report has been recommending the purchase of US bank stocks. For months now, US bank stocks have been dropping in price.

Earlier this week, Dick Bove of Rochdale Securities received a lot of heat after saying that people were “simply flipping out” about bank stocks, and that valuations were “ridiculous.” He pointed out, wisely, that although bank stock prices were falling, bonds prices were not.

Unlike stockholders, who tend to speculate, bondholders simply want the company to stay in business so they can collect interest and then get their money back. If a company is in danger of going bankrupt, bond prices drop. Yet, financial bond prices are holding steady, some even rising, showing that bondholders are not worried.

On Tuesday, billionaire Warren Buffett was at home taking a bath, thinking about how BofA was suffering confidence-wise and yet was solid financially. He called BofA and made them a win-win offer, and by Thursday morning (24 hours later) he owned 5 billion dollars worth of Bank of America, with warrants to purchase 700 million shares. When the news was released, BofA’s stock price rose 10% in a single day. Fortunately, I had loaded up on BofA stock just three days earlier, when it dropped after a string of rumor emails hit Wall Street claiming that the company was filing for bankruptcy.

US Banks are shouldered with large amounts of potential litigation (ie. they are being sued). They still own thousands of underwater mortgaged properties. Interest rate spreads are affecting bank profitability. Why would an investor with the stature of Warren Buffett be interested in buying bank stocks? Why would Berkshire Hathaway, Buffett’s company, be holding more than 40% of its total investments in the financial sector?

It’s simple. Great investors don’t care about rumors or fear, or whether the stock price is currently falling or rising – they just look at the facts. And, as a sound investment, the facts about banks are compelling. Bank of America is a perfect example:

Bank of America has a Mt. Everest balance sheet, with $140 billion in cash and more than twice that in securities. It actually has $13.86 in cash per share, yet the stock is trading at only $7.76. Put another way, for $7.76 you receive $13.86 in cash, $30 worth of securities, and a business that is gaining market share.

I have to admit, I have found the continuing drop in bank stocks to be both annoying (why are people still afraid?) and exciting (I can buy more!) at the same time.

Perhaps Buffett’s timely investment in Bank of America will finally make people see the light.


Update: On Monday Aug 29th, BofA announced it had successfully sold half of it's 10% stake in China Construction Bank, for a gross profit of 5.3 billion USD. A wise move if ever there was one.

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"A public-opinion poll is no substitute for thought."

Warren Buffett

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For more information, see:

Stock Market Flipping Out on US Banks

Buffett Bolsters Bank of America

BofA Sells Half of China Bank Stake, Raising $8 Billion

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Citigroup: the 1-for-10 reverse split

Some Citigroup shareholders woke up this morning to a surprise; they found that the price of their stock had jumped from around $4.50 to $44.00!

Unfortunately, today’s price jump was not an overnight stock rush, but merely a 1-for-10 reverse split. That is, if you owned 10 shares of Citigroup on Friday with earnings of $0.31 per share, you now own 1 share of Citigroup with $3.10 of earnings per share. In other words, aside from the price, there is no material change in your ownership. Why would Citigroup do this?

CNBC suggested on its website that the reverse split was done to “improve investor’s opinion” of the stock. Other blogs have suggested that doing a 1-for-10 reverse split is a way to “trick” or “fool” investors into thinking they are buying a better company.

Pardon me for saying, but if you think that a $40 stock is “better” than a $4 stock, or a $100 per share company is “better” than a $50 per share company, you need to stop buying stocks until you know what you are doing.

In fact, there are several good reasons for doing a 1-for-10 split, none of which are listed above.

The first reason is to counter day trading. When a stock has a low price but trades with high volume (like Citigroup), it becomes a favorite with day traders. For a low priced stock, a change of a few cents means a few percentage points, and so such trades can be profitable for a day trader. Unfortunately, day traders do not add value to a company the way that long-term shareholders do. Increasing the share price helps keep day traders out and, according to Citi CEO Vikram Pandit, therefore reduces volatility. In the very short-term, the exit of day traders will likely cause a drop in Citi’s stock price.

The second reason is to bring in potential institutional buyers, such as mutual funds. Many mutual funds are not allowed to purchase a stock that is priced below a certain threshold, usually $5 or $10. At $4.50, many mutual funds are simply not allowed to buy shares, no matter how good the company might be as an investment. Although a 1-for-10 reverse split doesn’t really change anything except the price, more mutual fund managers will now be able to buy Citi shares.

The third reason is to allow pension funds to buy the shares. Just as many mutual funds are not allowed to buy stock worth less than $5 per share, many pension funds are not allowed to buy a stock that does not pay a dividend. With 29 billion shares outstanding previously, Citigroup would have found it difficult to pay even a token $0.01 dividend per share. As of today, there are 1/10th as many shares, and so Citigroup can once again introduce a dividend. Once this dividend is in place, more pension funds will be allowed to buy.

Aside from growing revenue and earnings, part of any good company’s strategy is to manage their stock. Institutional investors and pension funds add stability, since they tend to hold for weeks or months rather than just hours. And, if many institutional investors buy and hold, this limits the availability of the stock, driving up prices.

Today’s 10-for-1 reverse split was an immaterial - yet smart - long-term move for Citigroup.

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"You never want to think the best things are in the past. You want to get yourself to believe that the best things are going to be in the future."

Sandy Weill, former CEO of Citigroup


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Stocks I Like - Citigroup

Citigroup – the company that almost went bankrupt in the subprime credit crisis, that received billions of dollars in government aid, and whose management has been called inept – is on my buy list.

Collectively, mutual funds and other large retail investors cannot buy Citigroup, because their unit holders would go berserk with worry. After all, the news surrounding Citigroup has been nothing short of scandalous. This situation presents an opportunity for the astute investor. For those who invest using logic rather than emotion and who can think beyond the next quarter, the big “C” is a great buy.

First off, the price: $3.79 per share at last close. This puts Citigroup shares at well below book value. As I wrote at the end of May, “At the moment, you can buy $5.61 worth of Citibank assets for $3.81, and get all their clients, brand names, and worldwide businesses for free.” And what a franchise it is.

Outside of the US, I have used Citigroup banks in Delhi, London, Tokyo and Beijing. Citigroup is a global business powerhouse, and its image - though tarnished at home - is relatively unscathed elsewhere. Citigroup’s worldwide reach is enviable.

The price of C has been hovering at just under $4 for weeks, and will likely stay there until the US government finishes selling its ownership - 2.6 billion sold so far, with 5.1 billion more to go. So, there is certainly no rush to get in. However, once the government’s stake is gone, Citigroup’s price will likely move sharply upward.

In a couple of years, I would not be at all surprised to see Citi’s EPS rise to the $2+ range, which at a modest P/E of 10 would give the shares a price of $20. Nice.

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"If a person is not willing to make a mistake, you're never going to do anything right."

Sandy Weill, former CEO of Citigroup
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Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.