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Are banks still good value?

Media Room, On the Internet | Comments (16)

Are banks still good value?

Bad PR and reregulation at home and abroad combine to create serious headwinds for bank stocks. They really do need to fight the regulatory cloud hanging over them. And investors should only be buying at very big discounts to intrinsic value – which currently don’t exist. Read Roger’s article at www.eurekareport.com.au.

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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16 Comments

  1. Ben
    :

    So since we are seeking banks to be at a significant discount to IV. I have an IV for WBC for 2010 of $23.49 with 2011 $24.11 2012 $24.79 and 2013 $25.52 . Am I in the ball park? I used a RR of 10%

  2. fred
    :

    Hi Roger,

    A question regarding share buy backs. In your book you explain how a share buy back can increase or decrease the value of a company depending on the price it pays but I have read some where that there can be a sinister act on the part of a company being involved in a share buy back. Could you explain this please?

    Thank you for all your help always.

      • Lloyd Taylor
        :

        Roger/Fred,

        I suspect Fred is referring to the very positive impact of share buybacks on the value of management’s share options in a business and frequently the favorable impact on short-term incentive payments to management.

        Capital can be returned to shareholders in three ways:
        1) Direct capital return (i.e. a cheque to each shareholder).
        2) Directly via Dividend (i.e. a cheque to each shareholder, with a different tax qualification as to the nature of the payment) .
        3) Indirectly via share buy-back (i.e. the only ones who get the money are those who sell shares into the buyback).

        The first two do not flow in any way to option holders and in effect decrease the value of the options compared to their pre-distribution value.

        The third mechanism increases option value in a number of ways. Firstly it can be manipulated to place a short term artificial price floor under the share price (particularly relevant is management is exercising options at a time of inflated share price).

        Secondly, by decreasing the number of shares on issue it generally has a positive impact on option value by lifting EPS and other accounting measures that are usually at the heart of the vesting rules of managements option plan. These improved accounting measures are frequently manifest in the targets or performance hurdles of management’s incentive plans so that buy backs can be used to game the incentive plan and positively influence payouts under the plan.
        Therefore, share buybacks frequently play directly to management’s short-term remuneration.

        These are the reasons that management teams always prefer the indirect return of capital to shareholders via a share buyback.

        Share buybacks ensure management’s snout is deeper than ever in a deep trough. This has led in the past to some exceptionally egregious buy back practices, particularly in the US where debt has been effectively used to fund share backs accompanied by a lot of financial engineering to dress up the short term accounting performance of the business around the time management exercises vast amount of options.

        So yes share buy backs can be the cover for a lot of “sinister” practices that facilitate the transfer of wealth from the shareholders of a business to the management of a business.

        I view buybacks with a healthy degree of skepticism and in my experience they usually presage a decline in the performance of a business.

        Regards
        Lloyd

      • Roger Montgomery
        :

        There is a solid argument that the combination of hired management (rather than owner management) and small shareholders, is the worst combination for long term value creation. Management are worried more about what they’ll get next year rather than the long term durability of the company and shareholders have given them the mandate to do it because with the ease-of-exit, shareholders have a short term focus. In Sweden shares can be issued with 0.1% voting rights and so families can remain major stakeholders for generations and concentrate on the long term. The combination of incentive driven managers and small shareholders leads to GM et al. The idea that a company should be run for shareholders is a furphy when those shareholders turn over 100% ina year.

      • Lloyd Taylor
        :

        You simply have to ask yourself this question: If the share buyback is such a great value adding deal for shareholders, then why isn’t management and the board of such a business buying shares with their ears pinned back?

        If you examine companies that have engaged in major share buybacks you will find that around 80% of them have underperformed both a financial performance and market value growth in the years following the buyback. The reasons for this are several, but in large part relate to the management ethos that underpins the buyback decision.

        On the other hand, I estimate that eighty percent of companies that engage in a direct capital return and/or special dividend do the opposite.

        The buyback is quite a compelling exit signal in my experience.

        A couple of cases to watch for: CSL & BHP?

        Regards
        Lloyd

      • Lloyd Taylor
        :

        P.S. I should qualify my statement “The buyback is quite a compelling exit signal in my experience” with the caveat that this applies in anything other than the circumstance where the buyback is occurring at a material discount to IV. Usually in the latter case the management and board are also big buyers, so in this is the real signal of a value creating buyback I.e. significant business leadership buying on top of the buyback.

  3. john
    :

    Hi Roger,

    I agree with your evaluation of the big 4 banks. However, Mr Market has a tendency to over value the big four. Thus we never really get an opportunity to buy these stocks at huge discount to their intrinsic value unless the market is in freefall. As for the bad PR and reregulation most people are usually to busy with their own lives to remember how poorly they have been treated by the banks.
    Should we not consider these facts if want to add these stocks to our portfolio?

    More importantly, your friends with the crystal ball foresee trouble waters ahead, have they mentioned any likely time frame?

    Regards

    John

  4. Ashley Little
    :

    Hi Roger

    Great Summary,

    Implied growth of inflation.

    With a return on total assets of 1% most retail investors have no clue how risky investing in banks are.

  6. Greg Mc
    :

    Ah, Valueline, my reason for getting up on a Wednesday (pity about having to wait until 7.30pm and go to work in between).

    Good article. Austalian investors, particularly the over 50s tend to judge the banks through rose coloured glasses due to their performance over a long period of time and those fat FF dividends so beloved by SMSF trustees. A cold non-misty eyed assessment like this article illustrates that for most people, investing in banks at the moment (and for a while now) is merely ok at best and that’s assuming that nothing nasty is lurking in the near future.

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