Community Bank Stocks: How to Cash in From Banking Reforms

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community bank stocks - Community Bank Stocks: How to Cash in From Banking Reforms

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I am a huge fan of the big money and investing shows. Each February when the Money Show comes to Orlando, Florida, I head down to the Gaylord Palms Hotel and have a grand old time. Mind you, I have never been to a presentation at one of these, but since I have many friends in the investment world it’s a great time to meet up with folks who are in town to give a talk or just escape the cold and snow.

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It is no secret that community bank stocks are one of my favorite subjects. Over the years, I have made more money in little banks than anything else. Right now we are in the early stages of what will the third long-term consolidation wave I have seen in my career.

The first one lasted from 1991 to about 1999 and the second one from 2002 until the bubble peak in 2007. Each was born in the aftermath of a severe market or economic meltdown that took bank stock prices to a fraction of book value  and eventually reached a peak valuation that was multiples of book value.

I call this the double compounding effect, and investors who take advantage of this powerful trend can make enormous amounts of money from community bank stocks over the next seven to 10 years.

Right now, the aftermath of the credit crisis has caused the various legislative bodies and oversight agencies to pass massive amounts of legislation to prevent another meltdown in the banking system. The bulk of the new regulations apply to all banks, both large and small, and the costs of complying with all the new rules are crushing the ability of small bankers to turn a profit and remain competitive.

At the same time, regional banks are finding that the combination of higher costs, a relatively weak economy and a highly competitive market place mean that the only way to grow earnings is to buy another bank.

This takeover wave is going to last for years and as time goes by, the price based on price-to-book value multiples that acquirers are willing to pay is going to go higher. In the last two long-term consolidation periods, takeover premiums started out at about 1.2X book value and eventually peaked at 2.5 times book value or higher.

Right now the takeover premium is right around 1.3X tangible book value for community banks with average financial performance metrics. I expect that to move higher over time and peak out at 2X or more the current level.

It will not happen overnight, but it will happen. If we bought community bank stocks with a book value at 10 and paid a 15% or more discount-to-book value, and sold it in seven years at 2.5X book value, that works out to a return of 16.6% annually.

Here where the double part comes into play. As credit conditions improve and the economy just sort chugs along, our bank will be growing book value each year. It may not be a great growth rate as its struggles with regulatory costs but it should grow a bit, year after year. If our bank can grow book by 5% a year book value, will be $14 a share in seven years. A takeover by a larger bank at 2.5X book value now yields us $35 a share. That works out to a compounded annual return of 22% a year on our original investment on community bank stocks.

That is the stuff of which legends and great fortunes are made.

The current bank merger and acquisition wave is in the early stages of what should be a very long cycle. There are still plenty of community bank stocks trading at book value or less that have decent loan portfolios and are in good financial shape.

Buying them now could pay spectacular dividends over the next decade.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/02/community-bank-stocks-cash-banking-reforms/.

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