As a resident of Seattle, the failure of Washington Mutual last week really strikes home. I know lots of people who work there, and many retirees who held its shares to the bitter end. So well loved and respected is the company that you hear stories like this:
The son of a friend who works there decided to put a sizable portion of his bar mitzvah money in Washington Mutual shares last year. After its value fell by more than half, my friend and her son had a discussion about how the market sometimes misvalues companies and that provides opportunity to long-term investors. After hearing that chat, the young man decided to double down on his mom’s company—and his parents helped by shoring up his losses to date.
Well, you know what happened next. It’s not pretty. They lost it all last week.
This is the kind of story that turns people off to stock investing for a generation. Maxims about long-term investing are always populated by stocks that have stood the test of time, such as Coca-Cola (KO), Procter & Gamble (PG) and Wal-Mart (WMT). Somehow the examples of companies such as Washington Mutual, Lehman Brothers, Fannie Mae and Bear Stearns don’t intrude.
However, I do want to provide a quick counterpoint that you can ruminate upon, or tell your kids. Both occurred to people close to me.
My favorite story about the success of longterm investing—i.e., having the happy fortune to hold good stocks through thick and thin—happened to a friend about 15 years ago. His father had been a factory worker most of his life in Cincinnati and later moved in retirement to the high desert of California and lived modestly in a trailer. When the gentleman died abruptly one day, my friend had to wrap up his seemingly meager financial affairs. He found among his dad’s belongings a safe-deposit box key, and after visiting the bank my friend discovered a handful of Intel (INTC) stock certificates dating from the mid-1970s.
My friend was shocked, as he never even knew his dad to have a single share of anything. So he asked his relatives in Cincinnati about the stock and discovered that back in the bear market of 1974 his dad had been watching "Wall Street Week with Louis Rukeyser" when the iconic host told viewers that they should take advantage of the sharp decline in prices to buy stocks. One of his guests recommended a new…
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…little electronics company called Intel, which had just gone public three years before, and so my friend’s dad apparently went the next week to a brokerage for the first time and bought shares in the stock.
The 25-Year Hold
My friend’s dad was immediately embarrassed about his purchase, according to the story, because they went down in value pretty quickly, and he didn’t want to tell his wife. So he put the certificates in a safe deposit box, and there they stayed for the next 20-plus years.
Now, obviously this story had a much happier ending than the Washington Mutual tale, as the shares that were bought for less than $1,000 were worth closer to $1 million by the late 1990s. Those shares provided my friend and his brother with a great retirement nest egg of their own, and fortunately they sold the shares in early 2000.
Great saga, right? But now I want to quickly point out that this was mostly luck, for if he had picked one of hundreds of other hotshot electronics firms of that time, the story would have turned out much differently. Or perhaps you aren’t familiar with the decline and fall of one-time superstars such as Xerox (XRX) and Unisys (UIS).
I’ll give you one more story like that: My wife’s father worked as an engineer and sales manager for Johnson Controls (JCI) for his entire career, at one point running all of Europe and the Middle East operations from the firm’s London and Brussels offices. When he died earlier this month, my wife and her brother discovered that he had refused his financial planners’ advice to dump his JCI shares over the years, holding through thick and thin.
And fortunately this story has a happy ending too, as that company has endured and prospered despite all the ups and downs of the auto industry to which it is now mostly tied. Consider if he had been a GM employee, shares would have lost around 12% of their value since 1985. Instead, they’re up more than 2,500%.
The Lesson Here is Twofold
One, is that if you want to buy some shares of badly beaten-up stocks for your kids to discover in a safe deposit box in 25 years, this is probably a pretty good time to think about doing it. But you better pick right, and beware that this year’s Google could be the next Unisys—or Washington Mutual.
And the other is that…
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…companies with a history of making popular, innovative branded things like Intel chips, McDonald’s hamburgers and Kellogg cereals are probably better than companies that only deal with ephemera like loans and media.
I’m going to be thinking about these two lessons myself over the next few months, particularly if the bear market drags on and will propose some stocks that might have what it takes to be owned for decades through war, famine and depression.
Lessons of WaMu, Part 2
As you probably know by now, Washington Mutual was closed by the Office of Thrift Supervision on Thursday of last week. It was handed off to the Federal Deposit Insurance Corp., which then sold its subsidiary bank to JPMorgan (JPM) for $1.9 billion. That means JPM paid around $1.11 for a bank that had traded as high as $43 in January 2007. And ironically, Washington Mutual had been one of the stars of the last bear market, rising from $11.65 in early 2000 to $34 by early 2000. The price was 8% of the stated book value it would have earned as a normal merger in better times.
What’s important is that JPM marked down WaMu’s $176 billion home loan portfolio—its worst holding—immediately by 17%. That amounted to taking a $31 billion loss on 13% of total loans. JPM also made some comments that if there’s a "deeper" recession or "severe" recession, it would expect to make another $6 billion to $18 billion in writedowns.
Now you may have noticed that JPM’s shares blasted higher by 6.5% last Friday, which is not what usually happens in mergers. One reason is that due to the writedowns and expected cost savings, JPM said it expects a 50-cent boost to earnings per share in 2009 as a result of the acquisition, and it’s looking for a move to $5 per share from $3.79 in 2010 so long as the recession doesn’t get much worse. The bank further said it expects losses on residential loans tied to U.S. home price declines of 25% to 37% (peak to trough) nationwide and 44% to 58% in California and Florida.
There are a couple things I want to point out:
1. Western regional banks gain share. Astute analysts at FIG Partners in Atlanta note that the removal of WaMu dramatically changes the banking landscape in the Pacific Northwest, Southwest and Florida, where the thrift did a lot of business. For one thing, you can forget about the 5% certificate of deposit rates that WM was offering near the end to attract deposits. But more importantly, local banks are going to have a field day taking market share away from "those New Yorkers."
I think investors will soon start to look over the trough toward improved prospects for stronger regional banks in the west, such as CVB Financial (CVBF), Cullen Frost Bankers (CFR) and Prosperity Bancshares (PRSB), as well as rebounding banks like Sterling Savings (STSA) and Zion Bancorp (ZION).
2. Writedowns make Wachovia faint. After the WaMu deal terms were announced late last Thursday, the steep writedowns that JPM decided to take on that bank’s Option ARM loans were not just an idle curiosity to holders of Wachovia shares. That’s because Wachovia made a deal in 2006 that will go down in history as one of the stupidest ever: It bought the king of Option ARM loans right at the top of the market, a company called Great Western Financial.
Wachovia has not taken nearly the sort of writedowns on its Option ARMs that JPM took on WaMu’s—so investors did it for them, knocking the shares down 27% in the day. So that is a cautionary tale for this very large Charlotte bank, and it gives us a clue as to how much toxic debt is still lurking in the system.
The bottom line here is that the WaMu deal highlights how fortunate we were to have steered investors like you clear of all financial stocks for most of this year, even when they seemed really cheap. But it also shows that there’s a lot opportunity ahead for the banks I’m now calling "national champions," such as Bank of America (BAC). To learn about more ideas like this, click here to learn more about Trader’s Advantage.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com today and check out:
