Of Optimism and Pessimism
I recently returned from Nicaragua, where I was attending the second Rancho Santana Sessions. We had a good group of people — both presenters and attendees — and there were free-ranging discussions about the future of opportunity in America. Some folks expressed pessimistic views, some optimistic views…sometimes this back-and-forth continued into the wee hours of the morning at La Finca y El Mar, the restaurant by the sea.
Though we did not plan it ahead of time, both Joel Bowman (the co-editor of The Daily Reckoning) and I gave talks peppered with cheerful conclusions. Joel came down optimistically on the political side of things (“the state is doomed”). And I came down optimistically on the side of investing in certain opportunities in today’s stock market.
The more I think about it, though, the less I like the optimist-pessimist continuum. What I am really advocating is a rationalist approach. I say be neither optimist nor pessimist in your investing. Be rational. Be opportunistic in the good sense of that term. (The word “opportunism” has negative connotations. It seems the English language does not have a term for someone who takes advantages of whatever opportunities present themselves that does not include this baggage.)
People get lost in big picture abstractions when it comes to investing. It is easy to look around and shrink up like a frightened turtle when looking at, say, the towering debt the US government owes. There is always plenty to worry about.
I don’t dismiss these things. I think they are important, and that’s why I write about them. I take them into account and try as best I can to invest around them. I also take a long view of history. We have been through worse. In every crisis, there are opportunities.
More simplistically, I hold to the basic idea that markets go in cycles. You want to buy when things are down and hold for inevitable rebounds.
So, in my Rancho Santana session I had this one simple chart that sums up how I think about investing:
In the real world, of course, no market works just so neatly. But if you look back over time, you find many such basic outlines. The chart below is one that I showed during my presentation on bank stocks. It shows the long-term cycle of price-to-tangible book value, the common metric of bank stock valuation. (The chart comes courtesy of PL Capital, an outstanding investor in bank stocks).
Notice the wave-like pattern of ups and downs….
And notice where we are today. Banks, as a group, are as cheap as they’ve been in 20 years. I don’t know when the cycle turns. I can’t predict where bank stocks will top out in the next up-cycle. But I say with confidence that bank stocks will once again trade for 2-3 times book value someday.
Since you can buy good banks for less than book value today, you have a great opportunity in this sector. The added kicker is that book values keep growing. You may worry about the economy, but banks have historically shown great resilience in growing book value after a crisis. Banking is a balance sheet business, as the sayings goes, and as balance sheets get better, earnings rebound.
I also showed this next chart on the banking industry in my presentation. (It comes from James Montier’s book Value Investing). It shows how book values halved after the crash of 1929 and in the early years of the Great Depression. But valuations recovered steadily even as the Great Depression roared on.
I can show other periods where banks also recovered steadily after a crisis. History never repeats itself exactly. And each episode has its own unique fingerprints. But I feel like the general pattern of the bank-stock cycle won’t be much different in the post-2008 world than it was decades ago.
To that end, I talked about Republic Bancorp (NASDAQ:RBCAA) as a favorite on the banking theme. The family-controlled bank has $25.88 per share in tangible book value that you can buy for $20.05 per share. That’s a price-to-tangible book ratio of 0.77. The bank has plenty of capital, a clean loan book and pays 66 cents annually in dividends. (We are also getting a special dividend of $1. That means we’ll enjoy an 8% yield in our first year.)
Another example of this sine wave sort of investment opportunity is in hotels.
Much like the housing bubble, the hotel market also got bubbly. Though it never reached the heights of prior hotel booms, it busted just the same. Today, there are plenty of distressed hotels around for sale.
Because the hotel market is weak, there isn’t a big rush to build new ones. In fact, the number of new hotels added to supply has steadily fallen since the crisis with a lag. (People finished projects started in good times).
So, here is another chart from my presentation. It shows the US hotel market and the annual supply growth. I think the up and down quality of the market is clear.
You want to buy during those lulls. We are in one of them now. As a result, you can buy good hotels for less than the cost to build them. Again, the strategy is to sit and wait until the market recovers. I can’t say when, but I am confident in saying that at some point the hotel market will get strong again. Property values will recover and then we’ll see an upward march in new hotel construction. That’s when you’d want to start selling.
So this was the gist of my talk. I tried to get people to think opportunistically and I tried to boil down my affinity for these ideas in the simplest way I could. I hope the attendees enjoyed my presentation. And I hope you enjoyed this summary.