New stock purchase: time to gain exposure to banks

Even as the Fed raises rates and with open talk of a US recession, this bank stock is simply undervalued

May 8, 2023

Following on from the obviousness of a banking sector in underwater territory, I have today opened a position in a bank and must warn you that this post mentions stocks I have an interest in.

It’s ironic that I’ve decided to gain exposure to the banking sector on a day when this news headline flashed across my screen:

The fact is that the regional bank sector is under a lot of pressure from the failure and bailout of three banks since March of this year and a fourth is teetering on the brink.

But a lot of the market panic about the banking sector is in my view overdone, especially when you consider that the US economy would take a massive beating if banking were allowed to implode.

It seems to me inconceivable that the US government would allow that to happen.

So today I opened a position in Bank of America (NYSE: BAC).

How I got from regional banks to Bank of America

After two hours of painstaking research and a call to my broker, it became clear that as a UK investor, I’m unable to gain exposure to my security of choice in the current climate: SPDR S&P Regional Banking ETF (KRE).

According to my broker, HMRC rules and the requirement by UK law for a KIID (a two-page fact sheet about a fund) means that an ETF tracking the S&P regional banks is not available to investors.

Instead, I took a look at the large-cap banks and applied Benjamin Graham’s relatively unpopular large company criteria and found that ROIC is not a good metric to value a bank. More on that in another post.

So in an old-school value way, I decided to use the price-to-book ratio* to rank the eight largest banks in order of margin of safety:

Citigroup: 0.48
Bank of America: 0.88
Wells Fargo: 0.88
Goldman Sachs: 1.02
U.S. Bancorp: 1.02
JPMorgan Chase: 1.45
Morgan Stanley: 1.54

*data from Morningstar.com

Citigroup has never traded above its book value for the last nine years reflected in the fact that its short to medium % returns v the S&P 500* are shocking:

1 year: -17.98 v -9.05
3 year: -7.33 v 50.26
5 year: -39.79 v 38.50

*data from roic.ai

Like with most things in long-term investing, you could have just bought the S&P 500 and be done with it.

Citigroup was out of the running.

Bank of America v Wells Fargo

In the end, it boiled down to a few salient points for BAC v WFC:

BAC’s earnings over the previous decade have been steadier/more predictable than WFC’s
BAC’s returns on equity have been higher in the recent past than WFC’s
BAC has printed higher profit margins over the short and long term than WFC
BAC is Warren Buffett’s second-largest position and has a 13% stake
Warren Buffett has been unloading bank shares since 2020 including Wells Fargo and JPMorgan Chase. He has kept Bank of America.

I would love to tell you that I use a prop DCF model or that I’ve spent 200 hours trawling 10-Q’s of the top eight banks, but that is simply not the case.

Most of my time today has been spent looking after seedlings.

I prefer to use a common-sense approach to investing from the Grahamite school.

In this instance, faced with an entire industry in a downward spiral, I’ve drawn from chapter 13 of Graham’s The Intelligent Investor entitled ‘A comparison of four listed companies’ in which ‘he should like to present a sample of security analysis’.

With the use of statistical data and key ratios, Graham highlights how a ‘conservative common-stock investor’ can compare a small group of companies against each other using statistical data/ratios to determine which stocks to include in a portfolio. The simplicity of this approach is its main draw.

Via a process of elimination, I’m long Bank of America.