Memo - March 8th, 2020
The markets have been getting wild, especially in the financial sector. There are a couple of opportunities in the market. I don't think that the S&P 500 overall is the big buzz because if you look at S&P 500 a year ago, it was trading at current levels – Shiller P/E of around 29. Further, corporate profits have not increased at the same rates as prices; therefore, it's expected that we might see abnormal forces on the downside.
Shiller P/E Ratio S&P 500
Two of the main fear in the market exists from the 1) coronavirus and the 2) inverted yield curve. While the coronavirus does have severed effects, I think that the market is overreacting. While the inverted yield curve has predicted seven of the last recessions, it would be irrational to make market forecasts. The U.S. GDP in 2019 was worth $21,200 billion. I think ten years from now; it is a high probability bet that the U.S. GDP will be higher.
United States GDP
Looking at the financial sectors, many companies have hit new lows. For example, U.S. Bank hit its five-year low trading around $32.57. The book value on December 2019 was around $29.37. Further, it is trading at a P/E ratio of around 7.83. US Banks' dividend rate is currently 5.16%. U.S. Bank is a cyclical company; however, their deposit base has increased over the last 10years with more branches across the country. Further, U.S. Bank buys back its share aggressively. This is good because we are not short-term traders.
Low-interest rates are unattractive to the financial sector. Banks around the world have struggled due to low-interest rates. However, banks such as Wells Fargo and U.S. banks earn a high return on tangible assets even in an environment with low-interest rates.
US Banks' current margin is around 29%. They have maintained this margin for the last 10 years. U.S. banks own offices and branches – real estate – in prime downtown areas across the country. Their book value – accounting – underrepresents their actual market value. Lastly, many U.S. banks have low derivative exposure compared to banks around the world. This reduces one of the risks for investors.
It makes sense that the financial sector is getting hit because 1) financial companies are cyclical, and 2) interest rates – feds funds rate – have decreased. However, Banks like U.S. Banks have a competitive advantage because most people rarely switch from one bank to another. For example, Wells Fargo, even with all their scandals, many businesses still do business with them. As the population grows in the United States, the demand for commercial banking will most likely increase. Additionally, with technological advancement, banks can operate at a higher margin because customers depend on features such as a mobile deposit.
U.S. Bank Profitability Ratios
Now, knowing anything could happen to the markets. I think it would be wise to buy a basket of bank stocks. Further, we should position ourselves, where if the market keeps decreasing, then we keep buying more aggressively (vice versa). This is my distinctive trait. Opportunities like these are rare and short. Therefore, we have to act fast and aggressively. I think this would be a wise long-term investment. Note, valuing a company is not as simple as looking at the PE ratio. Valuation for us differs greatly compared to the PE ratio.
Cordially,
Rojan Shrestha
