Bank Stocks

December 14th, 2007 by Potato

Unfortunately, I still have another few posts under money to come over the holidays; apologies to those of you bored by this already.

I know I just got through talking about diversification and mutual funds, and how I had parked some of the cash I was sitting on in my high interest savings account into a few low-cost index funds from TD. I warned against the hazards of trying to pick individual stocks to beat the market — since only a minority of investors do manage to beat the market. But my dad calls the stock market “the great casino” and of course, every now and then there is the great urge to gamble.

So shortly after becoming “fully invested” my beloved Trans-Alta (TPW.UN) has been bought out and my shares were forcibly redeemed. That’s left me once again with cash to invest somewhere. I could follow my earlier reasoning, and buy some more index funds and just hold on for the next decade. Or, I could look at the signs of dreary economic forecasts coming in and say to myself that this might be a good time to have some cash, and to not worry about buying anything for a while. Or, I could gamble.

I’ve been watching the bank stocks for a while now, and they have been hit fairly hard by this subprime/ABCP fiasco. And they deserve to be: there’s billions of dollars of debt at stake, and their loosey-goosey lending/accounting/risk management may pull the whole continental economy down into a recession. However, if any industry can turn it around in the long term, I’m sure it’s the banking industry. So, if the current crisis makes bank stocks a good value for a long term hold, then I’m going to look into that.

One bank I like is TD: they have quite good customer service including extended branch hours, and were the only ones conservative enough to stay the hell out of the ABCP mess. They’ve been fairly flat for the last few weeks and are probably close to their fair value. TD is probably the least risky Canadian bank at the moment for both the near and long term, but since it looks like a lot of other investors see it that way as well, it’s also not “value priced” at the moment.

Going to the other end we have CIBC. While I love PC Financial, which is offered through CIBC, I’ve never been a direct customer of theirs and have heard of customer service problems from other people that have been long-standing. They’ve also managed to dig themselves into the deepest pit of any Canadian bank with this subprime mess. Will they lose a billion dollars? TEN billion dollars?! It’s not going to be pretty whatever happens, and there’s still a lot of risk and uncertainty there. However, they’ve also had the ever-loving shit kicked out of their stock, down 20% in the last month, about 8% in the last week alone. So with a stock like this, at what point is the price low enough to reflect the losses and risk factor? At what point is there a potential over-reaction and thus a potential value buy? When I was first looking at what to buy a few weeks ago, I read through a lot of information available on CIBC, and jotted down a quick note: “Don’t touch till $75”. Well, today it’s crashed through that point, closing down at $73.60.

Trying to value something like this is a skill I do not really have. I tend to rely a lot on people like my dad and stock analyst reports. Unfortuantely, my dad says that the risk is too big with CIBC at the moment, since they keep saying that they’ve released their bad news, just to have another batch of bad news come out the next week. No matter how cheap it may seem he’s not interested in touching it, so he’s not going to walk me through how he values companies. And I think the analyst reports I’ve read are wrong, overly optimistic, or at least out of date. So I’m going to have to wing it on my own.

There are a number of ways to try to put a value on a company’s stock, and I’ve probably never heard of the ones that actually work well, but here are two very amateurish methods I can try to apply to CIBC. First, we have price-earnings-ratio. This is the ratio between a stock’s price and the earnings per share. For instance, CIBC has about 335 million shares, and made about 3 billion dollars last year, or about $9/share. Many bank stocks typically trade at about 12X earnings, so to put it very simplistically you expect to buy about 12 years worth of earnings with your stock purchase. If there’s anything that might upset the forecast for future earnings (such as massive losses from a subprime mess), then you have to adjust your stock value accordingly. So if we imagine that over 12 years, CIBC might stand to make 12*3 = 36 billion dollars, but might also have 10 billion in losses from bad investments or an economic downturn, then we might project that the 12-year earnings would be $26B, or $77.60/share, and then we say that’s what the stock should be worth. If the losses are “only” 5 billion, then we might be looking at $92/share. Of course, things are more complicated than that, since the losses wouldn’t be averaged out evenly over the 12 years like that, they would happen soon, and things that happen soon are worth more (in this case, more of a hit) than things that happen later. There’s also still so much uncertainty about what’s going to happen, and uncertainty and risk carry a price penalty as well. This little analysis also started from the current year $9/share earnings, but that might be an optimistic start point, as that’s a pretty high earnings figure for this bank. The 5-year average looks to be more like $5.40/share/year. Using that to find 12-year earnings (~$22B), taking a subprime hit ($5B), and then finding the share value gives me something like $50/share. I think that might serve as a good “floor” price.

Another simplistic valuation is to look at the share price relative to the book value. The book value is about $33/share (about $11 billion total when you multiply that out). Take off a $5B subprime hit (and how arbitrary these numbers can be in the face of uncertainty) and that book value comes down to $18/share. The stock had been trading at something like 3X book value, which would put the new, adjusted price at $54. If the hit to book value is only $2B, then we’re looking at $81/share, which we’re already below.

From all this you can plainly see that I am not at all qualified to be doing this kind of value analysis without further training. However, I think that some point between $50 and $75/share, CIBC might be a good long-term buy. “Calling the bottom” is a very difficult thing to do, but I think if CIBC drops any more (below, say $70/share) I might buy some, though I’ll probably wait until it starts to turn around, possibly months from now. One complication is that the share price is quite high, especially compared to TransAlta, so I don’t have enough money to buy a “board lot” of 100 shares. Normally, I’d stay away from odd lots, but for big bank stocks there is so much volume, so many shares being traded every day, and so many dividend reinvestment plans producing odd lots that I think it’s pretty safe to not worry about getting a block of 100 shares and just investing what I can (and as always, only what I can afford to lose).

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