Using Schloss to Find Bank Bargains

 | Apr 17, 2014 | 1:00 PM EDT
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I have just about made it all the way through the week without considering the grand macro picture or the constant news flow that swirls around investors 24 hours a day, seven days a week. Keeping your head down and focusing on just valuations is the single hardest part of being a long-term, deep-value investors.

It is even harder when you have earnings season and several geopolitical hot spots flaring up around the globe. Companies are shedding or adding hundreds of millions of market value based on a quarterly snapshot. And the talking heads spend a lot time talking about the great trades that can be made to exploit the geopolitical situation. Just as it is almost impossible to stroll through the action in a casino without placing one little bet, the siren call of news flow can make it very hard to stay focused.

For our final screen of the week I want to take some of the basic principles of Walter Schloss and apply them to the bank stock universe. To find cheap stocks with a strong balance sheet and high levels of insider ownership, I have to tweak the criteria just a little bit. Debt-to-equity is not really a valid measure on the banking world so I will substitute the equity-to-assets ratio instead. Over the years I found that a ratio of 10 or higher usually indicates a rock solid bank, so that will be our cutoff.

The findings are similar to all the other stock searches I conducted this week. There are not many cheap stocks using this criteria set and most of the ones I find are small. Only three of the 21 stocks on my hybrid Schloss Bank Stock screen are over $100 million in market capitalization. Value investors will need to dig deep to find the real bargains right now.

Republic Bancorp (RBCAA) is on the list of potential bargain stocks. I have a small position in this one in older accounts, but if it declines just a little bit more it could become a backup the truck bank stock. The bank has made some smart acquisitions and has a profitable tax refund lending business in addition to its core banking operations.

Republic has an equity-to-assets ratio of 13.28 and nonperforming assets are just 1.13% of total assets, so the banks' balance sheet is pretty solid. The shares are trading at just 88% of tangible book value at the current price. The stock yields a little over 3%, so you get paid to own the stock. Insiders won 5% of the bank so they have a vested interest in a higher stock price.

First Financial Northwest (FFNW) still makes the grade as the stock is trading at 90% of book value right now. The bank has a very comfortable equity to assets ratio of 18.04 and nonperforming assets stand at just 1.67%. Insiders own 5% of the stock and activist investor Joseph Stilwell owns an additional 8.1% of the bank.

The bank has taken advantage of the low valuation and bought back around 13% of the outstanding shares. I really would not be very shocked if the Renton, Wash.- based bank was sold before the end of the year as Stilwell has been pushing management in that direction.

ESSA Bancorp (ESSA) is the final bank on the list with over $100 million in total market capitalization. The bank trades at 81% of book value right now and insiders own about 7% of the bank. The equity to asset ratio is 12 and nonperforming assets are just 1.93% of total assets.

Back in February the bank raised the dividend by 40% and instituted a stock buyback to take advantage of the current low price of the stock. Earlier this month they announced they had closed on the purchase of Franklin Security Bancorp in a transaction that allows them to expand their service area.

Keeping your head down and ignoring the noise is not the easiest thing to do even in a calmer environment. It can be done and in the process you can usually find at least a few safe and cheap ideas with the potential for extraordinary long term returns.

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