I looked up on my calendar and realized it’s the fourth Thursday in September. That means — in two months, I’m going to be sitting down with my in-laws for Thanksgiving. Now, I’m lucky. I like my in-laws. They like good bourbon, they have a penchant for off-color comedy specials, and they both can really cook. Here’s the thing though. There’s something really odd about Thanksgiving… Our annual discussion.
Talking Banks and Value Investing
You see. I don’t talk to my father-in-law about football, work, or where we’re traveling. We avoid politics, we don’t care for Hollywood, and we’re bored when the weather is 85 degrees and sunny every single day…
Want to know what I discuss with my father in law? Community banks. Seriously. We talk about U.S. banks that have less than $2 billion in assets. And we do it on the fourth Thursday of November.
What The Heck Do You Mean?
My father in law is one of the top community banking specialists in the nation. It’s not the most interesting story in the world. You rarely read about little banks in the Wall Street Journal or Barron’s. But, he loves them because they represent his favorite investment trend. Mergers and acquisitions in the banking space.
You see, there were 15,000 banks in the 1980s. Today, there are less than 5,000. And they continue to consolidate at an incredible pace each year. So how do you make the most of this trend? He likes to buy community banks trading under a tangible book value of 1. Why does this matter? Because you’re buying a bank for less than the sum of its parts.
Imagine there was a stock that represented a bag of cash worth $1 million. The tangible book value of that is $1 million. And if there are 1 million shares, each would trade for $1.00. Yet the stock might trade at $0.80 on some days. That would make the bank worth $800,000 on paper in the public market. The stock price is worth ⅘ of the tangible book value – or 80%. In decimals – that is 0.80 price-to-tangible book value.
Banks trade like this, especially smaller ones that go ignored. They might have a tangible book value – the sum of their parts – of $1 billion. But the stock is trading at a discount… say 75 cents on the dollar. In an industry where consolidation happens at 3% to 5% each year, the little banks that are trading under their tangible book value are the obvious M&A targets. So, he simply snaps them up. He holds them. And eventually, after a period of time similar to watching paint dry, a few of the banks are purchased by larger banks.
My father-in-law is a smart guy. He doesn’t speculate on the latest EV stock. He looks for outrageous discounts, and he buys, holds, and waits. Typically those banks will kick off a dividend and reward him for his patience, or the stock will move higher and back in line with its real book value.
But every now and then, he’ll send me an email that tells me about the stocks he was talking about on Thanksgiving. And darn, if he isn’t right. I’ll talk about a company that you can trade with this strategy on Friday.