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5. I'm going to throw out, one at a time, a bellwether stock, and I'd like you to tell me your quick take on the company, where it's at, how you see it faring over the next three years and whether or not you own shares. First off, Citigroup (C) - Get Report.
Citigroup we do own. We like Citigroup. We think that of the large mergers, it's been one of the best. In other words, of all the major financial companies that came together, this is one that was handled well, even though there's been some controversy over whether it's been handled better than the others, and we have confidence in
On the negative side, the stock has over the last couple of years done better than most banks, or most banking-related institutions and is not at quite as low a multiple as some of the other banks, so I'm not sure, even though we own it I'm not sure it's the most opportunistic place to put new money.
Since it is so much bigger and so much more diversified than other financial companies, is it sort of getting into the trap where folks are having a hard time figuring out how to value it relative to others?
I suppose you could argue that, and it's hard to know who should follow it. It's generally followed by bank analysts, but actually that's only a part of the company. On the other hand, the stocks seem to have done fairly well compared to many banks.
What you're saying is true, but I don't know if that hurts the stock. I mean it's true, people have trouble knowing who should follow it and what you should classify it as, but actually the stock price seems to reflect its full value.
How about Charles Schwab?
Charles Schwab is another pretty big holding of ours. And Schwab we're staying with: the reason we are in the stock is, their business has certainly suffered in this downturn, but their number of trades has dropped significantly. However, the assets under management have grown steadily, and they're still adding accounts and they're adding customer assets, but those assets aren't turning over and aren't producing as much revenue as they used to.
But I think that's just the kind of market we're in, and in the long run, it's more important to gather assets than it is to do a lot of trades, because the assets stay with you and the trades can come and go. And we think Schwab is the best of what I consider the electronic firms, and it's off sharply from its highs.
Particularly with the US Trust acquisition. That seemed to be a really intriguing foray into kind of the bigger fish investors.
Right. I think now you might argue -- which Schwab says is not a problem -- is would this hurt the relationship of Schwab with some of their financial planners, that they see Schwab as maybe a competitor, as opposed to an ally? But certainly, the high-net-worth business is going to be a growing area and it has high margins and more rapid growth, so you want to be there.
How about Merrill Lynch?
We hold it, but we have a little less than we did last year. Their business has held up fairly well, and Merrill Lynch was not a big player in the technology offering, so the evaporation in that business hasn't hurt them that much.
But then, I think it's done better than the other brokerages over the last six months, and so it's not quite as cheap. It used to be cheaper: you could buy Merrill Lynch at a big discount to Morgan Stanley, and now you reallly can't. So just on a valuation basis, I think it's not quite as attractive as it used to be, because the stock has been treated a little better.
Last one. Stilwell Financial (SV) ?
We're not in Stillwell. I certainly have tremendous respect for the people at Janus, but I talked earlier about the arithmetic for the asset managers and how you are starting the year with fewer assets than you averaged last year.
Crudely thinking, your revenues are proportional to average assets. So you take Stillwell and they're down, they're starting the year quite a bit below their average last year. So during the year, they need a lot of growth, just to get back to even. And you know, only a short time ago the market thought of Stillwell as the ultimate growth, earnings growth vehicle, and now it's very unlikely they can avoid turning in a down year in earnings. So you have to re-evaluate them on that basis.
6. I know this is a favorite topic of yours since the bank fund started in 1985, and that's consolidation. Do you see that this is kind of a tough market and what does that do to the consolidation scenario?
I still think we'll see a lot of bank mergers, but probably not as many as we did in 1997 and 1998 in the heyday. Last year was a very slow year for bank mergers.
The reasons why I think we'll still see a lot of pickups this year, well, first of all, there still are a lot of banks left -- 8,400 of them -- so there's plenty of fodder.
Second, the accounting rules appear that they'll change, and you'll be able to, for the first time, use purchase accounting without having to write off goodwill, and hurt your earnings to the amortization of goodwill. So that will make it a little easier to do purchase transactions than in the past.
Then I think there's been resistance to mergers the past couple years because people's stocks had sold off, and they thought it was a bad time to sell. And now I think this year, that situation has changed a little. First of all, the stocks vs. last March, have generally come back some. They're not selling at quite as depressed a price. Second, the glory days of 1997 and 1998 are getting pretty far back in the past so, what you could have sold for back in 1998, as time goes on, becomes less and less relevant because, who cares, and it's a different era.
And then, finally, with the banking industry slowing a little and nonperforming assets up, the glory of being independent doesn't look quite as good, either. When earnings were growing 15% a year and people were singing your praise at the annual meeting, it was a little bit easier to visualize yourself just wanting to manage your company forever and ever. As we move into a weaker economy, the go-it-alone strategy looks a little iffier than the idea of cashing in.
So, you have several things, I think, working to promulgate more merger activity than last year. Last year was a very slow year, so I think we'll see an increase in deals.
Who are some of the candidates you'd see on the buying side or on the selling side?
On the selling side, I'd see people I'd think of as trophy franchises and here, none of these banks have represented to me that they want to be taken over, so I don't mean to say that they're out there shopping themselves.
But I've had a look at
in Texas, or
in Missouri. They're the last surviving independents in their area and they've had successful managements that don't have high-risk run portfolios that I think are pretty highly regarded, and really, they're the only way for somebody to get into those important markets, so I think they become likely franchises for somebody to look at.
And when you get to who might look at them, one problem we have here as far as seeing -- one thing that's standing in the way of a lot of mergers, there isn't that big a pool of buyers. Because some of the acquisitive banks of yesteryear, like BankAmerica, First Union and Bank One have all had problems of various sorts and aren't likely to make acquisitions now.
So the buyers are the people in the best positions to make acquisitions -- Fifth Third,
-- people that have a history of making acquisitions and would be interested in it, but that's a fairly narrow universe. They can't buy everybody, so I don't think you have the same competition, and that's one reason the activity's been slow. You don't get the feeling there's a feeding frenzy and if you don't buy someone today they're going to be gone tomorrow; it isn't that kind of market, and I think that's one reason we haven't seen as many deals.
I think on a positive side, as far as seeing mergers, the arithmetic is very good, because the stocks I mentioned tend to sell as substantial premiums to many of the regional banks, and it would be possible for a lot of these people to do acquisitions without taking any dilution.
7. As somebody that looks and obsesses over the financial sector, what are you seeing that is not on others' radar screens, that people are flat-out missing?
Well, one of the things I think the market tends to miss is the growth opportunities that many of the financial firms have. If you measure the affinity of investors for stocks by
price-to-earnings ratios, the financials are always sort of second player, relegated to the back burner.
But actually, I think many of these firms, looking back 10 years from now, they'll have proven to have more rapid growth than the market as a whole, and one reason is, as the population ages in the U.S. and Europe and in Japan, everyone thinks of health care as an area that benefits, but the financial services are, too, and certainly demand for insurance-asset management brokerages is to some extent related to people advancing in years, so I think they have that going for them.
And then, I think a lot of analysts tend to over estimate the growth opportunities in some of the more technology-based or product-development areas of the market. For example in technology, there'll be many companies that might grow 40% or 50% over the next 10 years, but they'll be in the minority. Indeed, there'll be many others that'll have zero growth or negative growth.
So if you buy a random collection of technology companies, the actual earnings growth you're going to realize in your portfolio is probably much lower than most analysts believe. Everyone thinks they have the 40% growth names, but they probably have some that are zero or negative.
On the other hand, let's take the banks. A lot of our banks we own, they only grow 9% or 10% a year, but if they actually do it, 9% growth that you achieve is better than 40% growth that's a mirage. So I think the market tends to always underestimate the value of the predictability of the earnings growth of some of these financial firms, and their ability to deliver on it year after year, and how that's better than potential that's never realized in other sectors.
So I think looking back, people will think the actual earnings growth and the fundamentals of the financials really were worth a bigger multiple than they thought at the beginning.
8. Every fund manager, it seems, has a target in their head of what kind of return they might expect this year for their fund, for their strategy, their way of going about things. What kind of target do you have in your head, and where do you see that falling, relative to what you might think the broader market, the S&P 500 might do?
Instead of one year, can I say, maybe over three years? I hate to rifle shoot one specific year. I look at it over three years; the companies we're buying will average earnings growth of 10%.
Which is not a Herculean statement, I mean I'm being fairly moderate in my wishes there, but that's one thing we can do at 10%. Then I think the stocks are undervalued enough that their price earnings multiples can go up 5% a year just to get closer to where the market is. So if your earnings growth is 10%, 5% multiple appreciation, and then a few, say 300 basis points from stock picking and merger activities, then you're up, say at 18%, and 18% doesn't sound like a huge amount for someone that's bullish, but the market as a whole may only do 8% or 10%, so I think 18% would be good.
9. If you had to pick three financials today that you would have the most confidence in over the next five years, imagining that the rules were you had to buy the stocks today and you couldn't trade in or out of them, what three stand out to you as being most attractive?
OK, I'm going to go with one of the names I picked before: Cullen/Frost is sort of having scarcity value and being sort of a trophy franchise. I like some aspect of Texas in that I guess it's the fastest-growing state in terms of population; it'll soon be the second most populous state, if it isn't already, and Cullen/Frost is the only real independent there. The others either failed in the 80s, or they were taken over by other states, so they're the only kind of locally owned, sizable bank there, and I think that gives them a good advantage in that market, even assuming they don't sell to anybody. It just gives them a business advantage, and I like the economic conditions down there.
Then in the brokerage area, I'm going to go with a name I haven't mentioned before --
. If you had said, what do you want to buy this minute to hold for a year, I might pick Lehman because it's undervalued and a takeover possibility, but I think Goldman is really the worldwide leader in investment banking. And as we see that area developing, the American firms are really the leaders, and I think Goldman is the premier investment banker. I think they're going to succeed over the next five years.
And then, let me see, one more name. In insurance, I'm going to go with Aflac. They've got good management and
are very good at growing in certain specialized niches of their market -- they're probably one of the highest return, highest growth insurance companies.
10. Last question, and it's kind of an oddball one. You've heard of the suit against
Henry Blodget for his recommendations on
. If something comes of this, does this expose brokerages, if some folks start to allege that they were misled or they took their advice and lost money?
I assume there isn't any substance there. First of all, there are probably a million people that have bought tech stocks at Merrill Lynch and just one person filed suit, so it isn't that significant.
And I assume what the investigation will show is that there was no explicit tie-in, that the investment-banking angle was kept confidential and there was no specific quid pro quo where your bonus goes up this much if you recommend this stock.
He probably realizes if he's positive on the stocks, it tends to help the firm's business more than if he's negative, so that's an extra incentive to be positive. I think that's just kind of the way the world works. So it's possible he wasn't totally objective, but I think the suit alleges there was a tie-in, like he knew this wasn't a good company but he recommended it anyway because he was told to.
As an investor, it's not an issue to you?
No, because I don't imagine that there's going to be that kind of tie-in and, after all, people are wrong about the market all the time and you never know for sure when you say buy or sell you're going to be right. Any recommendation could, easily, with hindsight, turn out to be wrong, and I would assume, to sustain a lawsuit, you'd have to show that he knew he was wrong because he was on the take or something.
Because if there was some disclosure that wasn't made, a secret deal he had, a way he was getting paid that he wasn't disclosing, then I think he might be in trouble, but I doubt it's that. I think he maybe was saying what he thought, and if he did err, it was just a general bias knowing that they like you better when you're positive than when you're negative.
So, the original question was, is this a show of liability for the brokerage firms? I don't think so because I don't assume these suits are going to go anywhere.
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