Today it was announced that TIAA was buying Everbank (EVER) for $19.50 per share. Everbank is a very average bank with lower returns on equity than the big banks. As of the 2nd quarter 2016, Everbank’s tangible book value per share was $13.24 meaning that TIAA is paying right around 1.5 times tangible book. Because of the regulatory and political framework that surrounds the big banks, these types of buyouts cannot occur, but the business values are ultimately what matter, as they drive stock prices over the long-term. There is no reason that a profitable and well-capitalized bank earning a 10% return on tangible equity should not trade at a minimum of tangible book value. When interest rates go up, returns will improve dramatically, likely leading to valuations far beyond tangible book.
Just as importantly, the banks that had the furthest to climb coming out of the Great Recession, such as Citigroup and Bank of America, actually have the easiest path to achieve earnings growth irrespective of interest rates. This is achieved through a combination of efficiency savings and loan growth. While it can seem frustrating that the banks have traded at such discounted prices for so long, in the long-term this works in our favor because these companies are finally in a position to materially buy back their own stock. This is a huge and underappreciated development, which should allow for growth in book value per share well in excess of 10% this year and perhaps for the next few years. As the stocks converge with intrinsic value and as their intrinsic values grow, we are well-positioned for double-digit returns in an overall market that could very well be flat or negative over the next 3-5 years. As always, predicting the timing is a fool’s errand, but we’ve seen some very good developments this earnings season. When you take concentrated positions, volatility can work you or against you. Focusing on the short-term movements is not helpful as it can create euphoria or panic that is unjustified with respect to business fundamentals. When you look at the quarterly and annual reports of our large holdings, the growth in intrinsic value is very apparent. Each quarter, book values are going up, capital ratios are improving, and capital returns to shareholders’ are being raised. To see the attractive returns that I believe are highly likely, all we need is a bit of sentiment shift towards the sector. This could occur for a variety of different reasons.
Friday’s strong jobs report, building off of June’s big number is a great start as rates are already nicely higher. Perhaps the election in November being resolved will reduce uncertainty and augur in a period of new business investment. It is also equally possible that people look at the market on a fundamental basis once more. Bonds are in a massive bubble and will lead to trillions of dollars of losses for investors. Stocks as a whole are overvalued. In this environment, there is one opportunity that sticks out like a sore thumb and this is in financial stocks. They are absurdly cheap by any valuation metric and business fundamentals are very sound.
There have been some very positive developments for other key positions such as AIG, AGO, VOYA etc., which I’ll be writing about in the days and weeks to come. It is a strange thing to be so optimistic on our opportunities while feeling so the overall market so unappetizing. This is most like the late 1990s but the bubbles are in different areas. Many value investors had their best returns despite the stock market crashing in 2000,2001, and 2002. I’m not predicting a downturn that severe but I do believe most sectors in the S&P 500 are 20-25% overvalued for whatever that is worth. As always, if I can assist in anyway please don’t hesitate to contact me!