Wednesday, November 9, 2011

Are Bank Stocks A Value Trap?


I got together yesterday afternoon with a pretty savvy client.

The meeting was great - as always, we had a spirited exchange of ideas.My client likes not only to hear some of my recent investment thoughts, but challenge my thinking as well.

We got to talking about the financial sector, and banks in particular. I reiterated my generally bearish views on the financial stocks despite the fact that on a pure valuation they look very attractive.

My client - who used to manage money for a couple of decades - pointed out the some of the historic valuation metrics for banks could be flawed.

He noted that banks used to be like utility stocks are today: boring, slow growth stocks whose main attractions were dividends and stability.

Money center banks today have little resemblance to the large banks of a generation ago. Any restrictions on their activities have largely disappeared. Banking is also much more concentrated in just a few large entities which, as the events of 2008 illustrated, are largely "too big to fail".

I think my client is right: simply saying "oh, look how cheap the price/book ratios are for the money centers" is not necessarily going to be a good guide to profitable investment opportunities.

Even if the crisis in Europe is contained to the European banks - which quite frankly I very much doubt - banks still face the prospect of very slow loan growth in a world focused on de-leveraging.

Moreover, with yields in the bond market so meager, net interest margins are being pressured like never before.

I remain cautious on the group.