In general, value investors like Warren Buffet owe a lot to their success in making purchases when assets are under-valued. This happens when an industry or sector is pummeled due to events unique to their industry. Many are suggesting that this is such a time for financial service companies and that the recent slide in bank & brokerage stock prices means this is a buying opportunity. I don’t agree.

                           

First, the case for buying:

  • After the Bear Stearns fiasco, Lehman Brothers and other commercial and investment banks have been successful at raising capital to shore-up their balance sheets.
  • The Fed’s seeming willingness to do whatever it takes to bail out commercial and investment banks.
  • 1st quarter write-downs at JP Morgan Chase were smaller than anticipated.

The case for not buying:

  •  Ratio of Stock Price to Tangible Book value (Price / Book). Financial stocks in the S&P500 were trading at a 10% premium to book during the last major US banking crisis. P/B peaked at a 350% premium a few years ago, and is still at 150%. Lots of room to fall.
    • Price Earnings ratio (P/E). The P/E of the leading 50 US Banks was recently 13.2. Compare this to a 25 year average of 10.2, and a 1990 value of 5.7. 
    • One of the largest sources of bank profits in recent years came from securitization of loans (collateralized debt). This has all but dried up and is not likely to make a come-back anytime soon.
    • Count on new bank regulation that will help prevent banking system melt-downs – and tie bankers hands – limiting growth.
    I’m not rushing to buy bank stocks or finance sector funds any time soon.