On Sale: Big Banks
Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since the largest financial institutions melted down in 2008, investors have been given buying opportunities that present an amazing value. Those who bought at the lows have seen multibagger gains as a reward for their risk tolerance in the face of uncertainty and fear in the markets.
But there are still more gains that could be had over the next several years for investors in these companies. With low price-to-book ratios and the beginning of dividends again, many of the largest banks still represent a great deal for prospective buyers.
Why we panicked
We investors looked around, we saw the news reports, and we thought that the system was melting down and we were headed back to the stone age. Okay, maybe we were not quite that afraid, but we were definitely shaken up. The glory of the everlasting rise of real estate fell apart, and the largest banks were receiving government loans. This was not the way 21st century American capitalism was supposed to work!
But the buying opportunities were there. Common shares were at record lows and many preferred shares traded as low as $0.20 on the dollar. Those who were brave enough to buy these companies earned phenomenal returns, but those who invested a significant sum of money directly with the company got even better deals.
Buffett buys a bank
When Buffett invested in Bank of America (NYSE: BAC), he didn't hit the little "place order" button in his Scottrade account. He hammered out a deal with B of A directly, which gave him 6% preferreds, commons at $6.99 per share, and 10-year warrants at with a strike price at $7.14.
If that sounds like a good package of B of A investments, maybe the company would be willing to cut you a deal if you invest $5 billion like Buffett did. The truth is an average investor does not have access to the same deals Buffett does, because they don't have billions in capital to invest. But Buffett still saw potential in B of A, enough to take warrants with a strike price of $7.14.
Buy one, get one free!
Just because you cannot get in Buffett-like deals does not mean you should shun investment in big banks. Trading at only 0.6 times tangible book value, B of A still offers a value play for those who buy the common stock. Also trading at 0.6 times tangible book value, Citigroup (NYSE: C) offers another potential bargain while also trading at 8.6 times earnings, similar to B of A. Citigroup shareholders have been hurt even more by the collapse, as they saw their stock be reverse split after extreme share dilution had increased the number of outstanding shares to more than 20 billion.
For those who look across the pond, even better values await. Royal Bank of Scotland Group (NYSE: RBS) trades for a mere 0.2 times tangible book, and slowly recovering Bank of Ireland (NYSE: IRE) is changing hands at 0.3 times tangible book. These banks are still enveloped in the fear of a complete Eurozone meltdown, and their prices reflect that situation. But if one is willing to bet on a recovery for the region, these firms offer excellent value plays.
A few words of caution
Even though we have pulled back from the abyss, the companies still are somewhat risky. While they are unlikely to go bankrupt, they still could be hiding some bombshells somewhere in themselves. The Eurozone banks also have the risk of, well, being in the Eurozone. Vulnerable to conditions beyond their control with great uncertainty, RBS and B of I should be considered more speculative than their American counterparts.
But these banks offer amazing value trading at fractions of their respective tangible book values. With a stabilizing economy, the American banks are safer now than at any other point post-crisis while the Eurozone ones still carry significant risk. When the economy begins to grow again at a decent rate these companies could return to their tangible book values if not passing them. Under this scenario, even if you did not buy them at the very bottom, there are still multibagger gains that could be made in these banks. But it will likely be a long term gain over the course of several years, not the quick rebound buyers saw in 2009.
Alexander MacLennan does not own shares in any of the companies mentioned in this entry.