Earnings season has begun and thus far almost every one of the banks that have reported have beaten their earnings estimates. The stock prices haven’t yet reflected the improving metrics, but over time prices follow business fundamentals, so there will be convergence. ALLY Financial posted an absolutely sensational quarter this morning with record earnings and its book value continues to grow. The stock has rallied nicely of late, but it is still way too cheap. The liquidation value is around $35 and the stock trades at roughly $28. We have a ton of sold puts on all these, which are still expensive due to the high volatility. As they expire, that premium accretes to our account values.
If ALLY seems cheap, Citigroup trades at about 60% of liquidation value. They probably will be able to buy back 15% of their market capitalization next year, if the stock stays this cheap. Because the Federal Reserve required the banks to halt stock buybacks earlier in the year they all have excess capital. This means that, starting next year, we should see massive stock buybacks and at these prices, which will be enormously accretive. Whenever we have seen these types of prices, and stock buybacks due to excess capital, the results have been quite powerful.
We are now 17 days away from the election. Tensions are high as we all know. We should see a large stimulus package passed either before or after, as both sides want to spend big, but sadly it is a political game. The economic data is mixed as retail sales were very strong but industrial production was weak. Our economy still has large states such as California, New York, New Jersey, etc., that have substantial restrictions. The unemployment rates in those states are far higher, so once they do reopen more we could see some really impressive jobs numbers. Historically, value stocks have done very well after Presidential elections, regardless of which side wins. 2016 was one of the most powerful rallies I’ve ever experienced, while 2009 was even better, so two different parties each generated good results. It often marks a cyclical rotation, so that could be very good for us.
This has been a challenging year on so many fronts, but I have a very high degree of confidence in what we own. The only time I’ve seen valuations like this were early 2009 in value stocks. The returns coming out of that were the most explosive of my career and it was with those funds that I started the company with in 2011, where we recently celebrated our 9-year anniversary as a company. The contrast between value and growth has never been this great. Apple for instance, trades at 37 times earnings. Citigroup trades at 5 times earnings. Apple’s dividend yield is .68%. Citigroup’s is 4.75%. Apple is not even really a growth stock when you look at their net income. Citigroup has actually grown earnings per share at a faster rate the last few years, although earnings will be down this year, and will resume growth next year.
Obviously there are no guarantees, but I wouldn’t be surprised to see a 40-50% move in our portfolios’ over the next 12-18 months. That is how cheap things are. It is simply unsustainable and while not owning more Tech has really hurt us in this work-from-home year, it should really help us when we see mean reversion. The S&P 500 trades at a very expensive multiple, but our portfolios are about 1/3rd as cheap. You don’t get these disconnects often and they are huge buying opportunities. Another potential catalyst to keep your eye on is a vaccine approval. The treatments for C-19 are definitely getting better as the Regeneron data looks very promising. Eli Lilly has a similar treatment, but it was paused temporarily as someone got ill, but that is not uncommon on trials, so hopefully that one proves safe as well. I know it is hard, but patience and discipline will serve us well. Investing should not be emotional and when we look at the data, we are at a point of maximum undervaluation with improving fundamentals. The proof will be in the pudding, but let the strategy play out with the options and the long positions.