Smart Guys, Cold Cash and Small Banks

One of the best lessons I have learned over the years is that although I am a pretty smart guy, there are plenty of people smarter than I am. I have learned to set aside ego and be smart enough to listen to them. Back in 1946 two brothers chipped into buy a hotel in Lakewood New Jersey. With an eye of the principles of buying companies for less than they were worth, also known as value investing, the two brothers and then their sons grew that fledgling partnership at 17% a year for 50 years. The company today is known as Loews (L ). They own oil and gas companies, insurance companies, pipelines and luxury hotels that have a combined value of $15 billion. I would say that anyone that can maintain that type of track record for that long is probably smarter than I am. They are certainly far more successful. I make it a point each quarter to read the transcript of the Loews earnings call. The Tisch Brothers learned well from their fathers and have done very well for themselves. Their comments are insightful and contain tons of useful information about the economy and markets. This quarter CEO Jim Tisch had this to say about the current pricing outlook right now" Current valuations for companies and assets don't lend themselves to the kind of equity returns we want. We are looking for the right deal at the right price, either a company with good cash-on-cash returns and strong secular growth trends or distressed undervalued assets at an advantageous entry point in the cycle." In response to an analyst question about their high cash balances ($5.5 billion or almost half their market cap) Mr. Tisch responded "Let me just talk about where I think the market is right now. I think that after all these years of low interest rates and quantitative easing, what we have is markets both fixed income and equity markets that are priced for perfection. Stocks are almost at new highs, the NASDAQ reached new highs last week, the S&P is within a shot of it. Today as we speak, the market multiple is I don't know 16, 17, 18 times earnings. When you look at companies that are auctioned in the private equity world, what I would say is that 10 is the new 6 and what that means is in the old days when companies would trade at an EBITDA multiple of six times, today that number is 10 times. And yes, interest rates are low but still it seems to me that even though you can finance at low rates, there just isn't enough room for return for the equity holder at these kinds of valuations. So, my guess is that for the time being businesses look like they're priced too high for us. Now one of the things that I always remember is that the world is cyclical. And it's easy to lose sight of that because we're now in - firmly in year six of an upcycle for equity prices. But at some point in time something will happen, people will lose all the confidence that they have and my guess is that opportunities will present itself. Like I said for offshore drilling, it could be a while and offshore drilling it's the next several quarters in the market for businesses, it could be in the next several years. But I'd rather be patient and get a good business at an attractive price rather than lose patience and buy a business at too higher price. " A lot of very smart people besides the Tisch brothers are holding cash right now because they cannot find stuff to buy. Warren Buffett is sitting on $67 billion. Seth Klarman is reported to be somewhere around 30% cash at Baupost. James Montier of GMO calls stocks hideously expensive and advises sitting on cash. At the Daily Journal annual meeting Charlie Munger told us that the secret to success in markets was to stockpile cash until an extraordinary opportunity comes along. In our broader Deep Value Portfolios that is exactly what we are doing. We cannot find much to buy that fits our definition of safe and cheap and I am very pleased to have the company of so many people who are much smarter than I will ever be. We are finding the opposite situation in our specialty bank stock portfolio. We are finding stocks to buy and are once again delighted to have some very smart people for company in this endeavor. Looking at recent 13 filings I find that activists like PL Capital, Joseph Stilwell, and Lawrence Seidman are buying small banks. So are folks like Sy Jacobs at Jacobs asset management. Michael Price is buying community bank Stocks. So are Manny Friedman and Robert Hurley and EJF Capital. Kahn Brothers has been buying bank stocks. Walter Schloss' nephew Paul Isaac has been buying bank stock at Arbiter partners has been buying the small community bank stocks. My good friends at FJ Capital are buying them as well. David Dreman has been buying bank as has value oriented mutual fund giant Franklin. Royce funds likes them as well and has been a buyer. There are a lot of very smart, very successful people buying the community banks and I have to talk you I am thrilled to be the dumbest guy in the trade. Look at what is going on in the banking industry right now, especially the smaller community banks. According to SNL Financial we are off to a great start in 2015 with the second highest numbers of deal announced since 2004. Kevin Reynolds an analysts at Wunderlich Securities said last week "Consolidation in the banking space is inevitable, especially considering the level of interest rates and a regulatory burden that disproportionately weighs on smaller banks that lack scale." Due to rising regulatory costs, and now the cost of upgrading and implementing new technology to stay competitive with a highly mobile populace smaller banks simply need to sell. At the same time conditions are improving for the community banks. Many of the community banks had double digit earnings growth in the first quarter even as larger banks struggled. That means that book value s are increasing across the sector and inevitably so will deal multiples as double compounding kicks in and makes investors a ton of money over the next few years. The smart money is buying and the trade of the decade is working. My only question is why aren't you in it?