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Wednesday, February 20, 2013

Great City, Great Banks

Earlier this month the Milken Institute study of the best performing US cities and metropolitan areas was released. The study ranks cities on things like job growth, wage growth, technology output and local GDP growth for the year. This study has some real value for investors as strong economic and of growth in a particular city leads to population growth and an increase in city and local tax revenues. Property values will stabilize and begin to recover much quickly in these parts of the country that have strong economic performance. Builders with a strong presence will do better than their peers around the country. Infrastructure contractors will see an uptick in contract awards and an increase in revenues and profits faster than many national companies. REITs with a strong presence in strong market will see higher occupancy rates and lease rates. An astute investor can use the information in the report to find all sorts of investable opportunities.

It occurred to me this morning as my coffee kicked in that the report is probably most useful to those of us that follow and invest in the smaller regional and community banks. A healthy growing job market means the region is going to experience income as well as job growth. This means higher deposits, more loan demand and improving collateral value. The business community will be looking for business financing and contractors will be borrowing to build homes to meet new demand. It is the start of the sweet spot of recovery for banks .Larger banks will want to expand in the region and often the easiest way will be to just buy a smaller competitor. Combining the Milken report with the trade of the decade in small bank stocks could provide some banks with huge potential returns.

The number one region last year was San Jose California. Business IT spending is starting to pick up once again and apps for smart phones and social media are exploding and this helped the region jump fifty spots to claim the top spot. The largest bank in the region is Silicon Valley bank (SIVB) with more than 20 billion in assets. The banks strong presence and reputation in the valley means the shares are not cheap. The bank trades at 1.6 times tangible book value. They have great relationships with the major players in Silicon Valley including the leading companies and venture capital firms.  The stock only trades below book in severe banking sell offs like the early 90s and 2008 but when it does it should be bought.

Heritage Commerce Bank (HTBK) is a smaller institution in the region that does not demand the same valuation premium. This stock trades right at tangible book value and has solid financials. The equity to asset ratio is a healthy 12.1 and nonperforming assets are just 1.56% of total assets. The bank has $1.14 billion in deposits spread among its 11 branches in the area. The bank projects itself as a community bank started by business people for business people and this is reflected in their loan portfolio. More than 80% of their loans are commercial and industrial or commercial real estate loans.  While this might be a red flag in a weaker region this is actually a positive factor in a growing region like Silicon Valley.

The company has been working to further strengthen the balance sheet and enhance its prospects going forward .They redeemed their preferred stock in 2012 and also paid off their subordinated debt prior to maturity. In the third quarter they had 13% deposit growth and posted their 9th consecutive quarter of profitability. Given the strong growth potential in the region the stock is cheap enough to buy and hopefully scale into even cheaper over time.

Apparently I am not the only one who thinks this is the case. Two insiders were accumulating the stock back in August. Value investing legend Michael Price of MFP Advisors owns almost 5% of the bank. Charles Moore’s Banc Fund Company LLC is also a large shareholder of the bank. In the third quarter of 2012 24 institutions increased or initiated a stake in the bank.

It is worth noting that for those willing to do the work there are several microcap banks operating in the region that are cheap with strong balance sheets and loan portfolios. They are way too small to mention here but some legwork could pay off for bank stock buyers willing to do the work.

As I move down the list on top performing cities I see that Austin Texas is second on the list. The Texas tech center is a perennial top ten city as the city has become a center of technology with Dell (DELL) and IBM (IBM) the largest employers in town. It appears that many residents are about to become cash rich if the Dell deal goes through. The problem with Austin is that almost all of the smaller banks are privately held. The largest banking presence in town is Wells Fargo (WFC) followed by Bank of America (BAC) so it hard to find a bank to buy and get an Austin specific play.

That’s not the case with the town in the third spot on the list. Raleigh, North Carolina climbed 11 spots in the annual survey as the research triangle attracted strong hi tech job growth. Universities are among the largest employers in the area and have been expanding research facilities. Cisco (CSCO) also has a strong presence in the region and has been upgrading their facilities in the region. Open Source software company Red Hat (RHT) also makes it home in Raleigh. The region has one of the most educated work forces in the area as it draws from North Carolina State University as well as nearby University of North Carolina and Duke. Tobacco Road has morphed into the High Tech Highway and the city of Raleigh is a major beneficiary of the transformation.

First Citizens (FCNCA) is the largest, and one of the oldest, banks in the area. The bank was founded in 1898 and has grown to more than 400 branches over 17 states. The bank has taken advantage of the recent crisis to acquire other banks with FDIC assistance and will emerge as one the regions strongest financial institutions. Officers and director of the bank own more than 40% of the outstanding shares so they have a vested interested in growing the bank and the stock price.

The bank traders right at tangible book value this year and is adequately capitalized with a tangible equity to assets ratio of a little over 9. Non-performing assets are over 3% but much of that is covered under a loss sharing agreement with the FDIC. The bank is over reserved with loan loss reserves at 1.62 times total non-performers  First Citizens should grow with the Raleigh metro area and be a solid performer over the next decade.

One of my favorite Trade of the Decade banks has a strong presence in the market. Capital Bank (CBF) is the combination of several smaller banks in the southeast that had their IPO just last year. Several of the banks were troubled institutions on the verge of closing and the deals were done with FDIC assistance. At first glance  the almost 7% nonperforming loan rates looks alarming but it has fallen from over 125 in a short period of time and many of the assets are covered under an FDIC loss sharing deal. Capital Bank has 15 branches with more than $500 million in deposits in the Raleigh Durham region making one of the larger banks in the area.

The stock is cheap right now trading at just 70% of tangible book value. The recent earnings report was not well received by the markets in spite of the fact they beat estimates. The bank also announced a buyback program of %50 million in common stocks. The equity to asset ratio is over 15 so they have plenty of capital to mange loan losses, support buybacks and hopefully initiate a dividend sometime in the future. They not only have a strong presence in Raleigh but also have a good sized presence several other Southeastern top performing cities.

Before I move on from looking at banks that are based in the best performing cities by the Milken Institute I want to look at one more region and share some general thoughts. On the list the dominant state is Texas as the combination of high tech around Austin, oil and gas centered on Houston , low taxes and a business friendly government have made the state one of the best places n America to do business. I wrote about Texas banks not long ago and they should be on your watch list for an opportunity to buy at a decent discount to tangible book value.

Utah is also very well represented on the list to the delight of our resident mountain man, Bob Byrne. A combination of oil and gas, agriculture and tourism have kept the state economically vibrant throughout the current slowdown. Unfortunately for investors most of the states banks are either industrial banks owned by corporate giants like Morgan Stanley (MS) and American Express (AXP). The best play in banking for the state to going to be Zions Bancorp (ZION). The bank has 107 branches with over $11 billion of deposits in Utah and is the 8th largest by market share. The stock has staged a nice recovery over the past few years but still trade at just 90% of tangible book value I have set up a news feed for bank IPOs of thrift conversion in Utah to see if the future provides any opportunities to take advantage of future growth in the state.

The last region I want to review is my old stomping grounds. The Washington DC economy has been somewhat impervious to the economic pullback for obvious reasons. The Federal Government is the largest employer in the region but every defense contractor, non-profit organization, union and technology company has a strong presence in the region. There are several major universities and research hospitals in the area as well providing yet another stable source of jobs.

It is also one of the more overbanked regions in the United States.  7 of the top 10 wealthiest counties surround the nation’s capital and that attracts financial services companies like honey does bees. I am hard pressed to think of a major money center or regional bank that does not have a presence inside the beltway. Back in the early 1990s the region saw massive bank consolidation in the aftermath of the S&L crisis but De Novo banks popped up on every corner as the decade progressed and once again the region has too many banks and consolidation is likely over the next few years.

Sandy Springs Bancorp (SASR) transformed itself form a small bank in the region to major presence by taking advantage of acquisition opportunities. Since 1993 the bank has purchased 5 institutions and engaged in two branch transaction that increased assert by close to $750 million. The bank has also purchased several insurance agencies and investment offices to expand their offerings in financial services. The currently have 49 offices thought the DC region with $3.9 billion in assets. The stock is a little high right now at 1.3 times tangible book value but it is near the top of my list of regional banks to buy on a market decline.

One of the more intriguing stories in the area is Middleburg Bancshares (MBRG). The bank has branches in the region surrounding the capital and location in Richmond and he Newport News area of the state as well. The bank has 11 branches with a total of $1.2 billion in assets. They also offer trust and investment management services throughout their service area. The stock is currently trading at 1.2 times tangible book value and has adequate capital with an Equity to assets ratio over 9. They real story here is that David Sokol, the investment manager once thought to be Warren Buffets successor, has been steadily accumulating the shares and now owns a little more than 1.5 million shares.  I own a tiny bit of this one and would love to see it pull back below book value and add more.

Like so many other regions of the country the real story in the Washington DC region is the small banks that are too small to cover here. There are dozens of them in the District, Maryland and Virginia that trade at a discount to tangible book value with pristine balance sheets and strong capital accounts. It is worth the time and effort for long term investors to find the safe and cheap bargain banks in the capital region.

The more I consider the idea the more attracted to the idea of mixing the Milken Best Cities report with the trade of the decade as a source of great bank stock ideas for long term profits.

Monday, February 18, 2013

Speaketh the Godfather

In the second round of twisting and misinterpreting quotes as a thought and literary exercise I set my sights on the holy grail of quotables. Guys of a certain age can quote the ‘Godfather” at length and many have based their life on the book and the movie script. The gangster fantasy lies somewhere in the mind of every man, the desire to live as one pleases, on one’s own term with total disregard for authority and the laws of the land. Of course the money, the women, the really sharp suits and cool hats have to be offset somewhat by the occasional vacation at Club Fed and the lead jacketed retirement plan but let us not mess up a good fantasy with any of that nasty reality.

Whatever some may think of gangster life style there is no question that the book, and the movie trilogy have provided us some incredible quotes that can help us frame life, markets, relationships and other critical parts of the world in which we live. There was a code, an ethos about the world of the Sicilian Mafia that had much to admire and perhaps something to teach us.

This is the Business We Have Chosen

This line is delivered by the Hyman Roth, nee Myer Lansky, character in the second film. It is an acceptance that if you choose the life you have to accept the price and there will be a price. Friends will die, you may go to Club Fed for an extended stay and there are expectations placed upon you for you membership in the mob. The real man is the one who accepts the risk without question and without complaint.

This can be applied to almost any profession but I certainly think it applies to those of whose work in finance and markets. Over the years I have discovered that, as a group, Wall Streeters can be whiny little shits. Just look at the social media feed of some of the traders, investors and bankers that regularly share their thoughts.  That guy stole my research.  This guy poached my client. They killed my deal at the 11th hour. The market maker fucked me. I can’t get a damn fill. The trade is going against me. My P&L blew up. My boss is a dick who doesn’t understand quant. I can’t believe they promoted that asshole. That guy has all the luck.

Look, you chose this life. Odds are you went to school specifically to work in finance. Half of you have been having a Wall Street wet dream since puberty and can quote Wall Street word for word. No one forced you to take a job on the overnight currency desk so quit bitching about it. There was no gun at the back of your head and some guy growling at you to trade Mr. Softy or he will blow your fucking head off. No one walked up someday and drug you into the back of a car to inform you that if you didn't go into I-Banking  the wife and kids were going to get it. There was no one threatening to break your knees if you didn't get long a leveraged line of coffee in front of a bumper crop or short corn as we entered a drought  You chose to be here. You are probably overpaid relative to your value to the world so just shut up and do what you came here to do.

 And please stop telling me how hard you work. Sitting up late at night flipping through stock charts and drawing squiggly lines is not hard work. Neither is updating your model to blow up the world or drawing up the latest merger proposal. Digging ditches is hard work. Teaching is hard work. So is nursing. Plumbing and bricklaying are hard work. Soldiering, now that’s hard work. Wearing an Armani suit sitting in an office with an exquisite view of the harbor crunching numbers is not hard work. Shut the fuck up and enjoy the fact that the only calluses you will ever get will come from golf and tennis. You chose this life. Quit whining and enjoy it.

I never wanted this life for you

I took a lot of flack last year when I wrote a column suggesting that the young  hard working young person today should avoid going into finance. After all this has been a rewarding life for me and I have reaped the benefits of working in markets and financial services. Why wouldn't I want my son to follow in my footsteps?

It is a valid question and I have a two part answer. First and foremost this is not the business I came into almost three decades ago. We sold stocks and bonds, maybe had a few high roller clients that traded options.  The best years of my life as a broker were at a regional firm that made markets in local bank stocks and was big in local muni bonds. We got well paid to inventory and offer illiquid securities as well tax free bonds. It was actually kind of easy to make pretty good money. You either wanted what we had or you didn’t and if you did, we got paid and you usually made money. The firm did well, the clients did well and the brokers did well. That business model has pretty much vanished from their landscape.

No one is a stockbroker anymore. They are all advisers and financial consultants. They are expected to do financial planning and consulting and know a little about everything. You are expected to swallow your credulity and credibility to sell packaged products to clients that any rational human has to know are just a horrid idea. If you show one ounce of imagination the compliance department will land on you like Patton in Africa. The firm wants more, always more and they do not really give a shit how you get it as long as its more. Clients are unwilling to learn even the basics of the markets and have unrealistic expectations and an aversion to paying you. It’s a shitty business. The firm is trying to fuck you in every way possible because you are the highest cost item in the business. The clients expect you to be god and will switch, or worse sue, at the first sign of mortality.

My second reason has to do with values and moral hazards. Wall Street no longer provides some valuable function to society. Do you really think that the deals that should be done can’t get done by guys like Buffet and Ross without I-bankers? Do you think that Dr. Smith cannot find someone to manage his assets without the big firms taking a cut?  When I first started in the world traders and speculators were a valuable source of market liquidity for investors. With as much as 90% of all daily activity being one spec trading with another can we really say we do that anymore? Wall Street is just spinning money and Main Street only exists as a place to package and lay off risk on unsuspecting clients. Yield to broker is far more important than yield to client these days in my experience.

Of course there are exceptions to this. There are firms out there doing deals for little banks and bringing new and innovative companies’ public. There are money managers and even brokers who really give a shit and bleed to do their best for clients. They seem to be the exception and not the rule.

I expect to see my kids do very well in the markets over their lifetimes. I want to see them use the techniques and principles of asset based value investing to put together portfolios that trounce the markets. I want them to learn to pick long shots that pay off in multiples not percentages. I want them to learn to think like old fashioned private equity guys and buy companies at ugly prices and sell them when they are pretty again. I just want to see them do it with money they earn running a construction company, a book store, being a teacher or almost any other occupation. If they go into money management I want it to be as a sole practitioner a jillion miles away from the Street and the poisonous culture of more. The only thing worse than one of mine going to Wall Street would be one becoming a politician as a part of the two party conspiracy. I hope they get dirty stinking filthy rich but I want them to do as part of something that adds real value to themselves and the community in which they reside.

Friendship is everything. Friendship is more than talent. It is more than the government. It is almost the equal of family.

  Friends are a huge part of what makes life enjoyable. This was not meant to be a solitary journey. I have always made it a point to make friends easily a cross wide range of the world. I am sorry but if you and all your friends work in the same business and live the same lives you are just fucking boring. To be sure I have a lot of friends who work in the markets. I also count Professors, chemists, fireman, salesman, teachers, mechanics, fisherman, restaurateurs, nurses, doctors, authors, artists and even a few government employees among those I call friend. I want a wide range of friends who know things I do not, who have had experiences that I have not. I want friends who add value and information to my life not just a collection of stock guys to sit around and talk markets and watch football. I can do that by myself.

Over the years a group of core close friends will develop. These are the ones who will be with you most of your life and be around for the highest highs and highest lows. They will be the ones you confide in and seek help from when it all goes to shit. The best way to figure out who your closest friends are is to lose all your money and see who is around the next day. It’s pretty much infallible. Your close friends are almost family. Treasure these relationships and give as much as you get from the relationship, if not a little more.

 Over the years you will have friends who betray you or harm you in some way. They will steal your money, make a pass at your wife, never repay a loan or in some way harm you in order to further their own good. You can forgive them but you still have to whack them. Some people will turn into a cancer that does too much damage to be allowed to be a part of your life. The braggart, the thief, the liar, they all have to go. Life is too fucking short.

The one person you better be friends with is the one you wake up next to each day. At the core of a real deep lasting love is friendship. It is not enough to be wildly sexually attracted to someone or get swept up in a moment of intense romance. These are very nice and need to be a part of every long lasting relationship. But at the core, to get though all the ups, downs and most all the sideways nothing special days of life you have to like them a lot. I am very lucky in that my wife is my best friend. I was and still am wildly attracted to her and she can turn me on with a glance but as much as I loved the romantic whirlwind of courtship I knew I needed to marry her when I realized she was my best friend and the person I most wanted to be around every day.

I don't trust society to protect us, I have no intention of placing my fate in the hands of men whose only qualification is that they managed to con a block of people to vote for them.

Okay this is the part that if you are easily offended by profanity or actually believe government in its current form offers much real value you should probably skip. This is one statement about which the Godfather was absolutely completely, intellectually and morally correct. I am always amazed that my fellow citizens accept the corrupt raging piece of absolute shit our government has become. We claim to hate politicians and polls show that everyone hates Congress but 91% of incumbents were returned to office last election.

Take note folks. Government cannot help you. They are not here to make your life better. They do not give a shit about you. The bureaucracy of government has but one mission and that is to sustain and grow itself. In order to do that they need to control as many parts of your life as possible and coach it in terms that offer you reassurance that it is in your best interest. Liberty is stolen with good intentions far more often than by gunpoint in our modern world.

We elect these people based on their promises about making your life and world better. The truth is once they get up there they want to control your life. They want to decide where you live, how you raise your kids, who you love, who you marry and what you do with your property. When a man declares his intention to run for office he is basically saying he knows more about what you need to be happy than you do and he intends to make it happen by the point of a gun under the threat of incarceration. A professional politician will do whatever it takes to get reelected. He will take your money and give it to someone else to gain votes. He will allow banks to corrupt the economy and pass out benefit checks to people who have never worked a day in their life. He or she will vote to regulate your job, your sex life, your hobbies, and wrap it all up in God and flag.

There is almost no difference between the parties. They both exist to keep the dance of the dollars and votes going as long as possible. Yet we all act like there is some major difference between the two. The only difference is how much of your money they want and which behavior they want to regulate. That’s it.

We need to quit electing professional politicians.  Quit fucking paying them would be my suggestion. I want to see us elect a single mother who is balancing kids and a job and has no time for bullshit. I want to see a guy who has had to sweat out the choice between paying taxes and making payroll in office. I want someone who has just had enough of getting fined for not wearing a seat belt or letting his kids ride a bike without a helmet. I want someone who has lost a business to some asinine government regulation and is just tired of the ridiculous and arbitrary nature of government sworn in. I want people who have busted their ass and brown bagged it to work to buy a house and put their kids through school. I want to elect someone who did five years in prison for smoking a joint or having a poker game in their home. I want someone who wants to see their kids taught reading, writing, math and unadulterated or politically corrected history and teach self-esteem and personal values at home. Lets try voting for people who understand that the best thing government can do is stay the fuck out of the way.  I did not sign any damned social contract and as much as you owe me nothing, I owe you nothing.

The governments job is to provide for the common defense and provide a level playing field for commerce. Everything else is an infringement on my liberty and an attempt to control my behavior. The government is no longer for the people, by the people and of the people. It has become for the politicians, by the lobbyists, and of the bureaucracy. It is our apathy and ignorance that has allowed it and only our passion to regain personal liberty and willingness to embrace personal RESPONSIBILITY that can change it.

Yet, he thought, if I can die saying, "Life is so beautiful," then nothing else is important. If I can believe in myself that much, nothing else matters.

This might be the most important passage in the book form which to learn. Don Corleone has seen some of the worst things life had to offer and had indeed perpetrated some of life's worst on others. But at the end as he fell dying to the ground he understood that life itself is beautiful and should be lived in such a manner as to embrace that beauty.

Look, I am a realist. Life is not all cupcakes and unicorns. Bad shit can and does happen. We will, beyond any certainty of a doubt, fuck up and probably often. I have been sick, had children with a serious illness and I have had loved ones die. I have been beat up, locked up and have fucked up royally. I have gone broke a time or two. I have had my heart broken in my younger years. I have made more mistakes that I can ever count and I am sure I will make more before I am done. There is a harsh ugly side of life and it is all too easy to wallow in the muck, the blood and the pain.

Politicians will tell us we have to sacrifice for the greater good. The church tells you that you must abstain to insure a better life in the next world. Puritans will tell you that you must keep your nose to the grindstone. The do-gooders and bleeding hearts will tell you that you must live for the benefit of others. To all of which I say “Fuck You.”

I am not on mutual conversation terms with whatever deity created our world but I am pretty sure they did not fill it with love, music, books, sunsets, sex, wine and joy for us to ignore it in hopes that we will have more fun the second time around.

I am aware that one must work and contribute in order to makes ones way through life but I do not believe that is should be the major focus on ones life unless you enjoy the hell out of it. Do what you love and the money will follow is not always true as quickly as we might like. Sometimes you have to work at a job you do not like with a boss that’s a raging asshole. But that does not need to be the focal point of your life and is but a step along the road. One should work to live until you can find the capital or ability to do what you love to do and get paid.

It is your life not someone else’s. You may choose to help others long the way but that’s a choice not a requirement. You do not owe anyone else one damn thing you do not choose to give. Give what you want to who you want.

Embrace the idea that for all its faults, life is beautiful. Quit focusing on what’s wrong and look to what’s right. Kiss your lover, listen to your childrens laughter. Listen to more music, have more sex, read more books, embrace all that is good, right and wonderful about being alive. It sounds trite but chase your dreams and strive to live the life you want. If you dream of palm trees and sunshine what in the fuck are you doing in the snow belt? If you always wanted to be a ski bum on your days off you need to imitate  my good friend the Yeti and move your ass to the mountains. If you want to enjoy things educated and literate why are you watching a Simpsons rerun? If you want to work for yourself and own a business why did you just piss away $137 on miller light and jaeger bombs? Figure out what you want out of life and then decide how to make it happen. Embrace all the small wonderful things about life. Read books. Drink wine. Watch more baseball. Love. Live. Life really is beautiful if you look for it.

Resolve not to die miserable and wishing you had taken more risks and chances.  Arrive at the end with a drink in one hand, a bag of memories in the other, wearing a  smile with one shoe on, one shoe off saying that like the Don you found life beautiful and worth living.

In ending I leave you with a quote that in my opinion could well hold the true meaning of life.


Wednesday, February 06, 2013

Wisdom from the (Gratefully) dead

Over the years I have had a lot of fun examining the remarks and scribbling of various literary, sports and market giants for useful advice. We have looked at quotations and outbursts from such luminaries as Earl Weaver, Hunter Thompson, Jimmy Buffet and even Travis McGee for some clues as to the meaning of it all and potentially profitable ideas with entertaining results. They are fun to write and force me to think  about meaning, context and even application of the remarks to various aspects of life and living.

Recently my fevered and perhaps mildly hung over brain began working on the spark of an idea to increase idea generation and writing output. Why not work on a series of these things selecting unlikely celebrities and literary figures and apply this little exercise on a regular basis? It seems to me that perhaps it would make a great writing and thinking exercise. It might be, or it could just be another one of those dumb ideas I practice for a bit before letting it slip into the circular file of history. We shall see.

The difficult choice was with whom to start this process. HL Mencken comes to mind as he had a sharp mind, acerbic with and a lot to say about a lot of things. Twain is always a possibility. Serge Storms has had some awesomely applicable quotes as a character in Tim Dorsey’s happily demented books. Chandlers Marlowe got off some gems as did Robert Parkers Spenser. Dylan and Prine have some cool lyrics that would be fun to riff about for a bit. Odds are we will get to all those if I am not lynched by denizens of the interwebs before we get there.

To truly set the tone for this series I think we need to look for life and market clues in the most unlikely dark and dusty corners of thought and prose. We will start our exercise with Grateful Dead lyrics as one of my proudest moments is still working Dead Lyrics into an article on the stock market. I love the Dead and have seen them several times live, and even remember a portion of several of the concerts,so we will start with a little interpretation of their tie dyed wisdom. Keep in mind that these will be my very liberal interpretation I may even spin the meaning to make my point. Don’t like? Don’t read it.

Talk about your plenty, talk about your ills, One man gathers what another man spills

Being a deep value guy and something of a vulture when it comes to the markets I almost had to lead with this one. I am constantly confounded that the value approach to the markets, as simple and profound to say nothing of successful as it is, simply eludes most people. They chase the popular, the exciting, and the volatile  well know situations that everyone else is trading. Odds that they end of up with different results, or even positive results over time, are minuscule  It is the guys who clean up the spills that seem to make the most money over time and they are far less frenetic and stressed in the process.

It is the companies that fall out of the index, that are ignored, spilled to the side by the bigger funds and the wannabe Soros and Cohen types that end up providing the best long term returns for investors. Spill away my friends, I need the money.

I may be going to hell in a bucket, baby, but at least I'm enjoying the ride.

Of course the world is going to hell in a hand bucket. It always has been and always will be. The collective ills and problems of the human race are overwhelming at any given moment in history. Deficits. Democrats.Republicans. European Woes. Arab Spring turns to Arab Nightmare. Global Warming. Mass shooting. Gun control.  Do you really think we are so unique or that our life is that much worse or more perilous that the generations that came before or will come after?

Try this out. Nazis. Great Depression, Slavery. Mongol Hordes. The Panic of 1907. 100 years’ war. The black plague. Cold war. Ice Age. Civil War. Typhoid epidemic. Prohibition.  Stalin and the great purge. Mao’s cultural revolution.  Polio.

 In the grand scheme of things the vast collection of humanity is going to always be experiencing bad shit. There will be wars, there will politics and other diseases that ravage our species. It has ever been, and ever shall be thus. Mankind starts fights, spreads disease and invents religions to justify and feebly explain it all. There will be hatred, greed, political parties and big banks as long as there is man. There will be wars, disease, shopping malls and chain restaurants as long as man dominates this planet. And there is not one happy damn thing we can do about it. The world will always be going to hell in a handbucket.

But we can enjoy the ride. Although the collective misery of the world will touch us from time to time we can live in a much smaller slice of humanity. We can live out our life surrounded with those we love and like and ignore the happy mess outside the door. There one hell of a lot of things to like about life. Great books, good music, soft kisses, sunsets, cold gin, poetry, sunsets, baseball, children (during those moments we don’t want to lock them in a little box until they leave home anyway), palm trees, holding hands, pelicans, alligators, dock bars, funky local eateries, Sunday morning coffee and newspapers, and the list goes on.

I can sit and fret about the worlds ills and woes or I can enjoy a good book , or even a bad one, while listening to Miles Davis, while my wife lies her head in my lap and watches a great movie. I can worry about how some dick headed trader at Goldman is going to do to blow up the world tomorrow or I can buy stuff that’s really cheap and take an afternoon nap. I can fret about which religion is most determined to kill me or mine or I can check the load in my guns and go off to watch a spring training game and enjoy the world born brand new on the diamond once again.

We are born, we live, we die and the world is a shitty place with the exception of that little corner of love music, literature and baseball we can build for us and ours.

When life looks like easy street, there is danger at your door

Having been in and around the markets a good deal of my adult life this is one to which I can relate easily. The fat man and the band probably didn't know they were singing about Wall Street when they penned these lines but they are. I have seen it too many times in my life not to appreciate that when you finally think you have it licked and all will be yours you are about to get royally and painfully screwed. Every time I meet someone who tells me they have found a new system or approach that is going to give them surefire winners that lead to a quick fortune, there is a temptation to kiss them on the cheek in the manner of a Mafia Don ordering a hit. They are about to die. It will be a messy nasty death as the markets once again attempts to teach the hard lesson no one ever learns.

I have known many people who were the absolute best at what they do. Most of them are humble people who do not speak of their greatness. Those that have bragged to me about being the best, or the smartest, soon suffer the fate of being relegated to the grave while still alive. If you are fortunate enough to be good at something, then be good at it. But keep your mouth shut. Cycles change and markets, like the world, adapts. Fate is a fickle bitch with a distaste for those who claim to have thwarted her so best accept your rewards quietly and humbly.

Sometimes the lights all shining on me, other times I can barely see

  This is life in a single sentence. There will be highs, lows and in betweens. Some time you will be standing on the stage in the center of the spotlight accepting the accolades of the world. Others you will be in the dank corner of the darkest cell wondering what the hell went wrong. Some evenings will find you sipping champagne on the deck of the ship and others will find you curled under the table chewing ground glass and swilling rotgut through your tears. Life is just like that.

You can attempt to smooth it all out but why would you?To pass on taking risks, chasing your dreams for fear of falling short, eschewing love to avoid heartbreak, avoiding friendship to avoid treachery, all of these sound like a poor miserable life. Many achieve it, settling for life in the bureaucracy or corporate middle, never rising, never falling very far, never feeling that deepest of pain but it comes at the cost of never feeling the grandest of joys. You can stay firmly on the ledge your whole life but the mystery and beauty of life is on the peak and in the darkest corners of the valley.

The trouble with you is the trouble with me, got two good eyes, but you still don't see

This is another fat man lyric I can easily apply to the markets. So much of what works is readily observable but no one want so see it. The simple truth is that if you buy sound companies when they are out of favor and cheap and just wait long enough you will almost always do well in the markets. The problem is we all want it quicker than that and in a manner that makes look like some kind of super fucking genius guru. Our short term mindset also works against us in our endeavors. The casino is open so we must play damn it! To hell with patiently waiting for assets to experience a resource conversion or to generate higher income levels over time. The quarterly number fell short of my expectations so I must sell. The company has a new wonder widget everyone likes this week so I must buy regardless of price.

The path to long term gain is actually pretty obvious. Build cash until the market experiences one of the hundred year storms we get every three or four years and buy companies for a fraction of their actual value. Most do not have the patience or are so blinded by the desire for quick gains and glory they just cannot do it.

Of course it applies to life as well. Get rich quick schemes are actually get poor quicker plans. If she looks like a treacherous slut she probably is one. If he looks like Larry the Lounge Lizard odds are that’s exactly what he is. If it looks too good to be true 99.9% of the time it is. If you think a politician may be lying he is. If your business associate gives off an air of dishonesty, hide your wallet. Much of life is obvious if we only use our eyes and intuition.

The Dead have so many great lyrics that I will just close with one more. This sums up the best way to live in my humble opinion and perfectly describes the blue print for a happy life. Think this one through and you will find answers to questions you didn't know you had.

Put your money where your love is

Tuesday, February 05, 2013

Geeks and Bunny Rabbits

I have said on several occasions in the past that I am something of a geek. In addition to reading news, SEC filings and everything else I can get my hands on during the day I am find of reading academic studies on the markets. There is a subset of us that pass these things around like baseball cards looking for an additional edge or tool to help us succeed.  I skim a lot of these and a good number end up on the floor as a good deal of all academic research on every subject is a result of the publish or perish mentality. This tends to produce a lot of faulty work and erroneous conclusions by authors who are writing for tenure not for real financial research and gain. A few however produce exploitable edges that can make me a better investor.

One such that I ran across recently was the work of recently deceased pioneer off quantitative investor Robert Haugen. Along with Nardin Baker of Guggenheim Investments he published a study entitled “Low Risk Stocks Outperform within All Observable Markets of the World. “The paper was a follow up to early work by the two that showed higher risk did not necessarily equal higher reward. This study applied the principle of buying less volatile stock to 33 different markets around the world covering 1990 to 2011.
The paper flies in the face of a traditional Wall Street theory that the higher the risk the higher the reward. Haugen and baker express the opinion that the wdely held believe is the reason the low volatility stock outperform their high flying riskier brethren. Money mangers are all taught Efficient Market Theories and the capital asset pricing model in school and as a result tend to embrace higher risk stocks to chase higher returns.  Most mangers tend to favor stocks with the most analyst coverage and media attention and these are the most volatile issues on the stock market. According to the study it is exactly the wrong way to approach portfolio management.

This is a potentially important study with amazing results so I intend to spend some more time on this subject. To start with I sat down and ran some numbers and set up a screen   for the most and least volatile stocks in the S&P 500 to see if we could draw any conclusions. I am not a grand mathematician or statistical genius so I drew up my screens using simple measures like beta and monthly volatility that are easy to find or calculate.
The riskiest stocks in the index that should be avoided according to the study include some of the current darlings of traders and investors alike. Netflix (NFLX) has taken shareholders on a wild ride over the last year and is one of the most volatile stocks in the index. Investors have made good money in Tesoro (TSO) over the past few years but this study suggest it is now too risky to own for the long term investor. Fossil (FOSL) has recovered some from its earnings related price dump earlier this year but the shares are still on the too volatile to own list. I was disappointed to see that Micron Technology (MU) one of my holdings made the list of no-no stocks as well.

On the other end of the spectrum the lowest volatility names in the index produced some stocks that you do not hear discussed on the TV too much.  The list contains all the typical lower risk consumer products companies like Procter and Gamble (PG), Heinz (HNZ) and Kellogg’s (K) . Drug companies like Bristol Meyers (BMY) and Johnson and Johnson (JNJ) also makes the list of low volatility under owned issues that should outperform their more popular brethren in the index according to the study. Tobacco may not be a popular industry but Reynolds American (RAI) and Altria (MO) are on the list of potential lower risk winners. One real bonus to this approach to viewing the markets is all the low volatility stocks tend to pay relatively high dividend yields.

The research by Mr. Haugen and Mr. Baker ties in nicely with one of my favorite questions for investors and traders. Why are you doing what every eels is and expecting better results? Traders flock to stock like Apple with almost three times the market’s volatility. Now that the stock has risen sharply Bank of America (BAC) has become a market favorite in spite of the fact the volatility is actually greater r the index by a factor greater than 3. Market participants tend to all focus on the same sectors and subsets with higher volatility and lower returns as a result. The evidence seems to suggest that the opposite approach would be less popular but more profitable.

The research of Robert Haugen and Nardin Baker that basically blows an enormous hole in one the investment worlds most cherished believes. We have been taught almost from birth that risk equals reward in the markets and that to earn higher returns one must take additional risks. It seems that this is not the case and lower risk, lower volatility stocks actually outperform the higher risk more glamorous issues. The two find that this is the result of what they call agency issues. Everyone believes the same thing and everyone wants higher returns. As a result everyone owns the same high multiple more volatile stocks with subsequent substandard results.

It is no  secret that I firmly believe that the unpopular stocks that trade cheaply based on asset value also outperform glamour stocks as well as the broader stock market over time. Today I want to see if we can combine these two factors to fund stocks that can beat the market over time.  I ran a screen for cheap stocks with lower volatility than the broader stock market to see if I could reach any valid conclusions that might make us some money over the next few years.

The first impression that leaps off the page is that the Trade of the Decade is on the right track. A very large percentage of the names produced by this screen are small banks. Most of them are micro and nano cap banks that I expect to see taken over before too many more years go by. I own a bunch of them on the list as part of my TOD portfolio and was gratified they fit in with the research by Haugen and Baker.

Some of the larger banks that I won and have mentioned before also make the grade as cheap low risk stocks with the potential to outperform the markets. Westfield Financial (WFD) remains one of my favorite picks among banks that have undergone a mutual to stock conversion in the past five years. The Massachusetts bank trades at 80% of tangible book value and they have excess capital to spare with a tangible equity to assets ratio of over 15. They have a loan loss ratio of just .30% which is among the lowest I have seen in a long time. They are wildly over reserved with a reserve to Non-performing loan ratio of 2.77 compared to the industry average of .6.

Essa Financial (ESSA is on the list of low volatility cheap bank stocks as well. The stock trades at just 90% of tangible book value and also has a solid balance sheet with a tangible equity to assets ratio of 11 and not performing assets of less than 2%. Berkshire Bancorp (BERK) is also on the list trading at 90% of tangible book value as well. They also have excess capital and very low loan losses and the shares can be bought at the current level.

One somewhat surprising find was that several mortgage REITs are on the list. Hatteras Financial (HTS) invests in agency mortgage backed securities and is trading at 80% of tangible asset value right now. The shares yield a little over 10% at the current price. Institutions own less than 60% of the outstanding shares and the stock has been far less volatile than I would have expected. The same holds true for one of my favorite mortgage REITS right now. ARMOUR Residential (ARR) trades at about 90% of asset value and yield a generous 13%. Institutions own less than 40% of the company and the volatility is far less than some of the more well know names in the sector.

The more time I spent with the list of cheap low volatility stock the more comfortable I became with the idea that Haugen and Bakers were on exactly the right path for long term investors. I am familiar with many of the stock on the list and own a lot of them as well. These lower volatility issues tend to behave very much like bunny rabbits. They can sit still for long periods of time until something comes along in the form of a strong earnings report, takeover, or other positive surprise. Then they are capable of moving very far very fast. Using volatility to filter cheap stocks can help add another way to build a margin of safety into our investment activities.  Safe cheap and boring is still the best path to exciting profits.