Analyze This! Little Banks Can Still Be a Good Buy.

With some hands-on research, you may find community banks that present uncommon value.
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Bank stocks have a mild case of the late-cycle blues.

Whether they deserve it or not is debatable. (See the Sept. 14 TaskMaster

column.) But either way, this is a good time to start thinking about how you'll play it when the cycle turns positive again.

The first step: Forget about the big banks. The real action is way down at the other end of the spectrum, where fly-speck "community" banks are both more abundant and a lot more interesting than the

Citigroups

(C) - Get Report

of the world.

These low-volume, small-float stocks aren't for everyone. (See Jim Cramer's Sept. 13

column on why he dumped his recently.) But if you're patient and into hands-on research, the good ones have a risk/return profile that's rare, if not unique.

Here's the typical community bank story in a nutshell: A big out-of-town bank comes in and buys up a smaller local one and proceeds to close branches, lay off tellers and generally irritate people. Local movers and shakers then start their own little bank, selling a few million shares of stock to friends and neighbors and inviting other bright local lights to serve on the board of directors.

The result is sort of a self-fulfilling prophecy: Everybody in town wants to rub shoulders with these guys, so the bank instantly attracts business. And by offering friendly, look-you-in-the-eye-and-remember-your-name service, it also snags a lot of refugees from nearby megabanks. It prospers, adds branches and eventually sells out to a superregional. The founders then take their profits and start planning their next little bank.

This is happening in virtually every decent-sized town, and hardly anyone on Wall Street is paying attention because of the stocks' illiquidity. So wherever you are, there are probably three or four (or maybe 10) little banks that almost no one is covering. You can visit, check out first-hand who's in charge, open an account, etc. This is the kind of tire-kicking that Wall Street analysts wish they had time to do.

Eighteen months ago, takeover speculation had pushed many community bank stocks to three to four times book value, says Scott Burford, an analyst with Sherman Oaks, Calif.-based

GBS Financial

. "If I could have shorted them, I would have," he says. But in the bank-stock carnage of the past few months, community bank prices have fallen back to earth. Many are now trading at one to two times book, while some thrifts (which are, for all intents and purposes, banks) are below book.

To find your town's community banks, track down your local business journal (sort of a mini-

Wall Street Journal

that covers the local business community) by visiting

www.amcity.com or calling the

Chamber of Commerce

. Then ask for a copy of the journal's "Book of Lists," which contains every conceivable local business stat, including which banks operate nearby, their size and some of their investment characteristics.

Or call the nearest regional brokerage house (also available in the "Book of Lists") and ask for its research on community banks. Most cover only the relatively big ones, but they maintain lists that go all the way down to the tiniest start-ups. According to Detroit-based

Roney Capital's

Midwest Banking Review

, for instance, Michigan has 10 publicly traded banks and thrifts with assets of more than $1 billion -- and 30 with assets of less than $1 billion.

Once you know what's out there, analyze them for the following:

  • Good numbers. Normal banking ratios apply here, same as with the big guys, so look for a high return on assets, relatively little bad debt and good rates of growth. For a benchmark, use big-bank numbers from Value Line or a Web-based research site.
  • Quality managers and directors. Managers should have serious banking experience and a history of delivering results. The board should have marquee names and/or people with useful expertise. "Having a developer on the board helps with real estate deals," says Burford. "Accountants are good because they can bring business to the bank."
  • A growing community. If the area is hot, then a well-run community bank will rise with the tide, and vice versa.
  • Nice, busy branches. Banks are like restaurants and stores: You can tell a lot about them just by walking through the front door. Clean and busy is good; dingy and quiet is bad.
  • Aging insiders. Illiquid community bank stock is not the best way to round out an estate, so as a bank's founders age, they start looking for ways to liquify. They often call local investment bankers, who then call First Union or Wells Fargo (WFC) - Get Report, and -- bam -- a deal gets done for three times book. Insiders' ages are usually published in a bank's proxy and/or a document called a 10-K that it files with the Securities and Exchange Commission.

Now, say you do all this and find a handful of good-looking community banks. Do you buy or do you wait? That depends on your take on the economy. Rising interest rates, a declining dollar and/or nasty Y2K surprises will put bank stocks to sleep (in the veterinary sense). But if rates have peaked and Y2K is a nonevent, then a fast-growing community bank at 1.5 times book will be a big winner.

Either way, start the research now.

John Rubino, a former equity and bond analyst, writes a column on mutual funds for POV and is a frequent contributor to Individual Investor, Your Money and Consumers Digest. His first book, Main Street, Not Wall Street, was published by William Morrow in 1998. At time of publication, he had no position in any stocks mentioned. While Rubino cannot provide investment advice or recommendations, he invites your feedback at

rubinoja@yahoo.com.