The Alpha/Beta of Bank Earnings
Bank earnings reports and outlooks have been taped out over the last couple weeks at the speed of blast email. The shared results and commentary are the beta of the group, and correlation is high. The differences in position, execution, strategy, and culture are where all the alpha lies, long and short. It's a good time to share a few observations. The conclusions, even disagreements, are your own. But this is how brainstorming works: someone says something, and another person may disagree. However, rather than argue, divergent views become the raw material of a better idea or a more valuable insight. Even if you think we are dead wrong, we have done our job. Especially if you think we are dead wrong. You're welcome. By the way, we purposely left out names and identifying characteristics. It matters not to whom we are referring.
So a few thoughts, a propos of nothing, as the saying goes:
1.) Banks of all sizes are using lots of adjustments and restructuring charges. Those may be conveniently excluded from earnings analysis and support high core forecasts. Nonetheless, the sun always sets on stunted book value growth. This is where we can unearth many of the secrets in the industry and in companies. In a world focused on M&A-related book value earn-back, book value dilution can come in different forms--overt and covert. Some forms have an operating ring to them.
2. For certain banks, restructuring activities look like a line of business. A bank CEO recently noted new leadership for investment banking, again. Said he would give the person time to wander around, meet the folks, and bring fresh ideas to their operating margin/ROE challenge. Expecting some feedback by year end. Should we really expect an inflection? Or just more restructuring charges. The age-old problem is costs versus revenue. What they really need is some good ol' positive market action to obscure their deeper issues. What they are getting is negative alpha; i.e., falling short of convincing customers to bring over business at healthy margins. We hear the most details on cost management and the fewest on customer service, product development, innovation, and (the big one) value-add. In the industrial world, value-add always shows up (or doesn't) in the gross margin while scale appears (or disappears) in the operating margin.
3. The market focus on bank net interest margins is overblown, given valuations (our opinion, not fact). We aren't worried. The tendency is to think whatever cycle the industry is in is permanent. It won't be. However, it's a key part of the narrative that feeds traders and momentum investors. "What should I do with my estimate next quarter?" Not a topic of real interest to us. Warren Buffet is a major investor in financial services companies. Always has been. We have said it before: he has the smarts and commonsense of an octogenarian and the investment horizon of a youngster. He understands the math behind time in the saddle, and it takes a lot to unseat him.
4. The broader financial services group continues to prove there is plenty to chew on, long and short. There is room to be great, and there is a price to be paid for being generic. That's an algorithm for long-term gains as well as valuable risk management positions in portfolio construction. We don't see any real need to run around other neighborhoods looking for new friends, or new trouble makers. The positive and negative investment biases are so strong so often that there is no shortage of ideas to work on. Bias is nutrition to a hungry stock picker.
5. Our thinking is evolving in two areas: ESG/sustainability as factors in equity investing, including investing in these sectors; and, that all-encompassing term called "fintech." In both areas, ecosystems (pun) are developing to cement the relevance of these topics. This includes a significant ramp higher for related career opportunities. And demographics are tailwinds to both trends. The new generation will not relinquish readily its leadership in these areas as suppliers and consumers of all things sustainable and technological. Plus, sometimes management just has to do the right thing.
6. Remember, this is a war of attrition. You have to know the objective and measure success or failure by the proper metrics. We don't think that includes next year's NIM. Either dig in, or decamp.
7. "I want to say one word to you. Just one word...Are you listening?" Dividends. "There's a great future in [dividends]. Think about it. Will you think about it?"
We will keep traveling and listening. We do not want for questions, nor do we need to rush the answers. That's a difference maker relative to the near 33,000 institutional investment strategies identified by a major investment consulting firm. We found a near-empty lane for one more.
KCA/Princeton Advisors, LLC
Princeton, NJ USA
Important Note: This note is for information and discussion purposes only. It contains no recommendations to buy or sell any security in any venue. All investing carries risk of loss of capital, including loss of all capital. You should consult your personal financial advisers before taking any action. You should fully understand your tolerance for financial risk. Past performance is no guarantee of future results. The author(s) undertake no duty to update this note, or identify and make corrections. This is not a solicitation to invest in any fund.