Thanksgiving is 16 days away.
A normal family spends Thanksgiving watching football, arguing over politics and eating themselves into oblivion.
But not mine… My family talks about deep-value stocks and community banks.
Are you laughing? Squinting your eyes? Turning your head like a dog that just heard a howl on a television? It turns out my father-in-law is one of the top community banking analysts in the country. So when Thanksgiving rolls around, I can always count on three things…
- My daughter to make a mess…
- My high school football team to lose…
- And my father-in-law, Tim, reminding me about a simple metric to find deep value in the financial sector.
The Banks Are Always On Sale
When most Americans think of banks, they imagine large Wall Street firms like Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM), Morgan Stanley (NYSE: MS), and Bank of America Corp. (NYSE: BAC).
But that’s an incomplete picture.
In the U.S., there are roughly 4,500 publicly traded banks.
Banks with less than $2 billion in market capitalization are known as community banks.
These financial institutions tend to have far fewer branches than their national or regional rivals. They cater to small business lending, consumer accounts and financing local institutions.
Hedge funds and large institutional investors like Warren Buffett ignore this part of the banking world. Their smaller market cap and more local focus make it difficult for these big players to invest in that space. That’s good news — because retail investors get to keep these companies to ourselves.
Now, here’s where the opportunity lies…
Over the past 30 years, community bank merger and acquisition (M&A) activity has occurred at a 3% to 5% rate… Deals come and deals go… And they will continue for the foreseeable future.
Because the primary need in the banking sector is capital in the form of deposits. Banks need consumer deposits to expand their customer base, increase their lending capacity and boost their shareholder returns.
There are only two ways to increase deposits…
First, a bank can experience an increase in deposits because more customers move to the region where the bank is located. For example, Naples, Florida —a booming city in Southwest Florida — has experienced a dramatic uptick in population over the past decade.
If a lot of people bring their deposits to a region and open accounts, the banks in that region can thrive.
But what about a bank located in a place where people are leaving? Cities like Chicago and Boston? If they want to increase their deposits… they need to buy other banks.
That’s one reason why M&A in the community banking industry was strong in Boston, Massachusetts, in 2021. People are leaving… taking their money with them… and heading to Sun Belt states like Arizona, Texas and Florida.
Tim Will Bring This Up… So Pay Attention
I’ll bring a bottle of bourbon to dinner and some other dish. But I’ll also make sure to bring a pad and pen. The key metric you’ll want to learn is known as “tangible book value.”
This metric measures the value of tangible assets. I’m talking about a company’s cash, its real estate, its machines and other physical goods.
If a bank trades under a tangible book value of “1,” that means it’s trading for less than the sum of its parts.
So if a bank is trading at a tangible book value of 0.80, it is trading at 80 cents on the dollar.
I know it sounds crazy that these valuations would exist. But they’re a deep value anomaly that exists in this market. The trick to this strategy is to buy these banks… and just wait for a deal to come.
This Bank Trades for 76 Cents on the Dollar
Let me give you an example of a cheap bank with great numbers and a nice dividend.
AmeriServ Financial Inc. (Nasdaq: ASRV) is a Pennsylvania bank holding company with roughly 20 branches across the central and western parts of the state. It also has a branch in Hagerstown, Maryland. This stock trades at less than $4 and has a tangible book value of 0.76.
That means the company is trading for 76 cents on a dollar of real assets.
It also has a dividend yield of 2.95%.
So how would I play it? I could buy the stock, and reinvest the dividend payments. I could build a position and hope an activist investor either pushes for a sale, or a larger bank aims to acquire it. This is a conservative yet largely market-neutral strategy. And it could make me a nice series of gains with far less market risk.
Waiting is the hardest part.
To your wealth,
P.S. I’ll visit Ask the Pros on Wednesday to discuss my expectations for the markets over the next 60 days. Don’t miss the event. Be sure to click this link to attend, and I’ll see you there at 9:30 a.m. ET.