BAC-WT - Bank of America Warrants

[giofranchi]

Dazel,

you know there are very few people who post on the board that I listen to as carefully as I listen to you. Never heard one irrational thing from you. And your thesis about BAC is very clear and convincing.

 

If I may, I have a question for you: what makes more economic sense, BV per share or Tangible BV per share? Because they are quite different… If you use BV per share, a multiple of 0.77 is a very good price indeed. If, instead, you use Tangible BV per share, the multiple gets to be 1.14.

 

Let’s say it is something in between: (0.77 + 1.14) / 2 = 0.95.

 

So, BAC is trading near “true” BV per share… just like BH…

 

With BAC you have an international brand.

With BH (imo) you have an entrepreneur who is doing exactly what I’d like to be doing myself, except at a much larger scale.

 

I choose the person over the brand.

 

And you might say: “Big mistake!... Buffett has always advised to go for the brand!”. Maybe… But what if I think I know how to judge Biglari’s achievements and decisions much better than I know how to judge BAC’s international brand? Shouldn’t we stick to only those things we at least think we know how to do? And I have said “we at least think we know”, because I recognize we might make mistakes anytime… both trying to judge what Biglari is doing and where he is going, and trying to judge how much resilient the BAC’s brand actually is.

 

Let me end saying I have almost no doubt BAC will do much better than BH in the near future.

 

Gio

 

[SharperDingaan]

It might be only a coincidence, but I don’t know a single person in the whole banking industry that I judge to be a great entrepreneur.

 

- The bigger the ship (brand) the less influence the captain (entrepreneur) has.

- Dominant global brands mint money irrespective of how well/badly they are run. Banking, engineering, luxury goods, beer ...

- The smaller firms give you capital appreciation, the big ones give you yield & stability.

 

SD

 

[giofranchi]

As to great entrepreneurs in the banking industry, there are plenty of them, although I suppose it depends on what you mean by entrepreneur.  I'd also point out that, in many cases as an investor, you don't want a great entrepreneur -- you want a great manager.  This is very true of the banking sector!  (It's why I'm a huge fan of Jamie Dimon.)

 

First of all, I absolutely don’t want to lecture people!! I have been accused before of lecturing… and I have already tried to say I couldn’t care less… Please, trust me: if I give that impression, it is only because I might have a too "forceful" way of presenting my ideas and points of view.

I know it is something I have to change, and I am working on it…

 

Second, if you know plenty of great entrepreneurs in the banking industry… well, then let me know the names!! ;)

 

Third, and I already know this is going to be the most controversial thing I have written in a while, I am not a huge fan of Jamie Dimon… Results are evidently not all that matter to me!

 

Gio

 

[txlaw]

Second, if you know plenty of great entrepreneurs in the banking industry… well, then let me know the names!! ;)

 

Robert Wilmers, Richard Davis, and Rich Handler come to mind. 

[ERICOPOLY]

If I may, I have a question for you: what makes more economic sense, BV per share or Tangible BV per share? Because they are quite different… If you use BV per share, a multiple of 0.77 is a very good price indeed. If, instead, you use Tangible BV per share, the multiple gets to be 1.14.

 

I'm not Dazel, but it makes sense to invest based upon earnings, not book value.

 

Buffett answers the question the same way.  I've seen him state it multiple times -- "earnings power".  He was asked a year ago if Citigroup interested him below book value, and he laughed and said that looking at book value was relatively silly, and that it's earnings that matter to the investor.

 

[jouni1]

Second, if you know plenty of great entrepreneurs in the banking industry… well, then let me know the names!! ;)

 

Robert Wilmers, Richard Davis, and Rich Handler come to mind.

could george kaiser fit in this bunch? haven't studied him too much yet but seems to fit the criteria.

[giofranchi]

it makes sense to invest based upon earnings, not book value.

 

Ok, then let me put it another way:

$2 / $14 = 14.3%

$2 / $21 = 9.5%

Am I buying a business with a 14.3% ROE, or a 9.5% ROE?

 

Gio

 

[ERICOPOLY]

it makes sense to invest based upon earnings, not book value.

 

Ok, then let me put it another way:

$2 / $14 = 14.3%

$2 / $21 = 9.5%

Am I buying a business with a 14.3% ROE, or a 9.5% ROE?

 

Gio

 

The $21 BV includes a bunch of goodwill.  I just totally ignore it.

 

[giofranchi]

Robert Wilmers, Richard Davis, and Rich Handler come to mind.

 

Thank you! I will surely look for them! ;)

 

Gio

[giofranchi]

he laughed and said that looking at book value was relatively silly

 

Anyway, I don’t understand… If you don’t pay-out any dividend, how is it possible that BV is “relatively silly”? Where are all those retained earnings supposed to go?

 

Gio

 

[ERICOPOLY]

he laughed and said that looking at book value was relatively silly

 

Anyway, I don’t understand… If you don’t pay-out any dividend, how is it possible that BV is “relatively silly”? Where are all those retained earnings supposed to go?

 

Gio

 

They go to Eric Holder.  Or to higher capital/leverage ratios (book value here would grow).

 

Otherwise, they mostly go to shareholders via capital return.  They will only go to book value if the bank needs to grow (like if there is the loan demand out there).

[txlaw]

Second, if you know plenty of great entrepreneurs in the banking industry… well, then let me know the names!! ;)

 

Robert Wilmers, Richard Davis, and Rich Handler come to mind.

could george kaiser fit in this bunch? haven't studied him too much yet but seems to fit the criteria.

 

No idea.  First time I've heard of the guy.

 

What do you think?

[giofranchi]

But don't you think that probably Buffett was laughing because BV is meaningless... if you are not sure to be profitable… and he meant he was not sure about Citigroup's profitability? That’s a completely different story!

 

Gio

 

[ERICOPOLY]

But don't you think that probably Buffett was laughing because BV is meaningless... if you are not sure to be profitable… and he meant he was not sure about Citigroup's profitability? That’s a completely different story!

 

Gio

 

Nope.  He's tired of people being stupid and focusing not on the obvious economic reward to investors -- earnings.

 

It's earnings power that matters.

[thepupil]

Buffett does not think BV is meaningless. BV and capital are what generate earnings. This article is a good illustration of his framework on Book Value, ROE, earnings, etc.

 

Of course, much of Buffett's success has come from finding business with intangibles and "moats" that allow them to earn very high reinvestment rates and returns on capital, but that doesn't mean the capital is meaningless. 

 

http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/

[Mephistopheles]

it makes sense to invest based upon earnings, not book value.

 

Ok, then let me put it another way:

$2 / $14 = 14.3%

$2 / $21 = 9.5%

Am I buying a business with a 14.3% ROE, or a 9.5% ROE?

 

Gio

 

The $21 BV includes a bunch of goodwill.  I just totally ignore it.

 

 

Why ignore the goodwill? I know Buffett also calculates return on tangible net worth, but isn't the goodwill real money that the company put up when making acquisition? So shouldn't be counted when calculating real return on investment?

[jouni1]

No idea.  First time I've heard of the guy.

 

What do you think?

i'm not sure yet if i should see him as an investor or an entrepreneur. BOK has grown nicely during his ownership but at a quick glance it seems like shareholders haven't gotten full benefit. he's also as old as the sky, so it's probably not possible to be long-term partners with the guy.

[ERICOPOLY]

it makes sense to invest based upon earnings, not book value.

 

Ok, then let me put it another way:

$2 / $14 = 14.3%

$2 / $21 = 9.5%

Am I buying a business with a 14.3% ROE, or a 9.5% ROE?

 

Gio

 

The $21 BV includes a bunch of goodwill.  I just totally ignore it.

 

 

Why ignore the goodwill? I know Buffett also calculates return on tangible net worth, but isn't the goodwill real money that the company put up when making acquisition? So shouldn't be counted when calculating real return on investment?

 

Why only count the goodwill for stuff you acquired but not for stuff you grew organically?  That just seems stupid to me.

 

So if you instead just put a price on the actual earnings capability, or "earnings power", you capture all of the above.  After all, if goodwill is to be based on anything at all of value, it's earnings power.

[giofranchi]

he laughed and said that looking at book value was relatively silly

 

Anyway, I don’t understand… If you don’t pay-out any dividend, how is it possible that BV is “relatively silly”? Where are all those retained earnings supposed to go?

 

Gio

 

They go to Eric Holder.  Or to higher capital/leverage ratios (book value here would grow).

 

Otherwise, they mostly go to shareholders via capital return.  They will only go to book value if the bank needs to grow (like if there is the loan demand out there).

 

Eric,

I’d really like to understand:

Who or what is Eric Holder?

What do you mean by higher capital / leverage ratios?

What do you mean by via capital return? Dividends?

Any multiple depends on growth: growth is not a need, it is an opportunity. And I bet you are willing to pay different P/Es if the opportunity to grow is there, than if it is not.

 

Gio

 

[ni-co]

Why ignore the goodwill? I know Buffett also calculates return on tangible net worth, but isn't the goodwill real money that the company put up when making acquisition? So shouldn't be counted when calculating real return on investment?

 

Why only count the goodwill for stuff you acquired but not for stuff you grew organically?  That just seems stupid to me.

 

So if you instead just put a price on the actual earnings capability, or "earnings power", you capture all of the above.  After all, if goodwill is to be based on anything at all of value, it's earnings power.

 

I agree. Joel Greenblatt has some great insight into this question in "The Little Book that Beats the Market":

 

Intangible assets, specifically goodwill, were excluded from the tangible capital employed calculations. Goodwill usually arises as a result of an acquisition of another company. The cost of an acquisition in excess of the tangible assets acquired is usually assigned to a goodwill account. In order to conduct its future business, the acquiring company usually only has to replace tangible assets, such as plant and equipment. Goodwill is a historical cost that does not have to be constantly replaced. Therefore, in most cases, return on tangible capital alone (excluding goodwill) will be a more accurate reflection of a business’s return on capital going forward. The ROE and ROA calculations used by many investment analysts are therefore often distorted by ignoring the difference between reported equity and assets and tangible equity and assets in addition to distortions due to differing tax rates and debt levels.

 

ROA is only useful to find out how efficient a business is compared to other businesses. You want to find out how efficient a company works: Which assets does a company need on an ongoing basis to do its business and what are the earnings it generates with those assets? A company doesn't need "goodwill" on an ongoing basis to do its business. Goodwill is the premium the company paid to acquire other businesses. It needs the assets of these businesses to keep on going but it doesn't need the premium it paid to acquire them. This is only backward-looking.

[ERICOPOLY]

he laughed and said that looking at book value was relatively silly

 

Anyway, I don’t understand… If you don’t pay-out any dividend, how is it possible that BV is “relatively silly”? Where are all those retained earnings supposed to go?

 

Gio

 

They go to Eric Holder.  Or to higher capital/leverage ratios (book value here would grow).

 

Otherwise, they mostly go to shareholders via capital return.  They will only go to book value if the bank needs to grow (like if there is the loan demand out there).

 

Eric,

I’d really like to understand:

Who or what is Eric Holder?

What do you mean by higher capital / leverage ratios?

What do you mean by via capital return? Dividends?

Any multiple depends on growth: growth is not a need, it is an opportunity. And I bet you are willing to pay different P/Es if the opportunity to grow is there, than if it is not.

 

Gio

 

Wikepedia has a story on Eric Holder

higher capital and leverage ratios are regulatory tools used to de-neuter the big banks.

capital return ->  I meant dividends/buybacks

there isn't much growth when your deposit base is this large.  eventually expect about 30% of earnings to be retained and invested at the return implied by the return on tangible book.  Return on tangible book matters more for a small company with huge growth potential -- "matters" in terms of the P/E you'll pay.

 

[LC]

IMHO, book value is just a yardstick. I use it more for capital heavy industries, i.e. how much operational capacity can this firm handle. If there is some capital intensive, cyclical company that trades for a fraction of book (let's say, because the cycle is on its way downwards), it can give me a clue that when the cycle turns, this company can handle XYZ amount of capacity. But that is just a yardstick to approximate future earnings (and obviously isn't exactly accurate, hence the yardstick approach).

 

Or in the banking business, if the firm has a BV of 100billion but NIMs are terrible and they haven't been earning much based on the loans on their book, that obviously sucks. But it tells me if margins expand they have the capacity to earn a heck of a lot more because of the large asset base. But again, the end goal is to get a handle on what the company earns or can earn.

 

For example, anyone here who owns/has owned a business...does your BV really matter on a regular basis? Not really. If I own a company with a BV of $100 mil but it only earns $100 thousand/year, am I a happy owner? Not likely. Will someone pay me BV for my company? Not likely. Even if I was able to grow BV at 10%/year in the past, that is useless information if there's no way future earnings will allow BV to grow in the future. I.e. I don't think anyone wants to be buying buggy whip companies with massive BV's and historical BV growth at a price based on historical BV.

 

 

[xazp]

Because in the hall of shame, BAC has won the "worst acquisition ever" award.  I believe they routinely overpaid for acquisitions over the years, and certainly in aggregate "what they paid" far exceeds "the value we received." 

 

If their acquisitions were good, you would see it play out in ROE numbers.

 

Why ignore the goodwill?

[xtreeq]

Earnings Are Key to Valuing Banks: Buffett

http://video.cnbc.com/gallery/?video=3000151816&play=1

[peter1234]

Earnings Are Key to Valuing Banks: Buffett

http://video.cnbc.com/gallery/?video=3000151816&play=1

 

Thanks. Notice how he talks about tangible book rather than book.

:)