After speaking with John Allison of Home Bancshares (HOMB), I knew I had a bunch of spreadsheet time ahead of me. His suggestion -- that as a bank moved up in asset level, its price-to-earnings ratio and performance became much better valuation factors than price to book -- made sense to me at some level.
I have never really thought about the idea, as I have always done just fine buying smaller, underperforming banks and then selling them to the high performers for a lot more than I paid. However, when you have been around as long as I have, you know there is more than one way to skin a cat -- and Allison has made a lot of money in banking, so I needed to test the idea.
The data suggests that he is correct. Buying a portfolio of higher-performing banks, as measured by return on assets, that have strong, recent earnings growth, does indeed beat the market. I looked at banks with 15% earnings growth and returns on assets over 1.5%, with P/E ratios less than 20. You outperform very nicely over the 15-year period, and crush it over the last five years.
Looking at a 10-year period, you lag the market a little, because you really get killed in 2007 and 2008 before rebounding very strongly in 2009. From 2011 fonward, this approach outperforms the market by 60%. Buying the highest-performing banks does offer market-beating returns over time, but it can be a bouncy ride.
We can markedly improve results by "Timming-up" the approach, a little. I took the top-performing banks with strong earnings growth and then limited my purchases to just those with a P/E ratio of 15 or less, and a price-to-tangible-book-value ratio of less than 2. Returns improve dramatically, and they do so in my favorite fashion. The portfolio does much better in 2007 and 2008, and this improved defence allows the model to outperform over the five-, 10- and 15-year timeframes. Over the past five, the model has outperformed the S&P 500 by about 70%, as banks have recovered from the credit crisis.
The current screen of reasonably valued, high-performing banks has some interesting names on it. BankUnited (BKU) has done a nice job of growing earnings and share price since it was recapitalized during the credit crisis. At 1.43x book value, the stock would not usually show up on my radar screen, but with an ROA of 1.15% and 30% earnings growth over the past year, the stock makes the grade under this approach. The P/E ratio is just 13, so the stock passes the growth bargain test.
I am bullish on Florida banks in general, and BankUnited has been one of the best-performing banks in the Sunshine State over the past few years. You get paid to wait for growth with this stock, as BankUnited shares yield 2.66% at the current price.
Porterville, CA-based Sierra Bancorp (BSRR) makes the grade as a growth bargain bank, as well. The bank has been making whole bank and branch acquisitions lately, and it is paying off for them. Earnings have grown by about 17% annually for the past five years, and are up 23% this year.
The bank is reasonably priced -- at 120% of book value and 12.5x earnings. The bank is earning a ROA of 105%, right now. You get a decent dividend with this stocks as well, as the shares yield 2.79% right now.
I was delighted to see that Hoquiam, WA-based Timberland Bancorp (TSBK) made the list. I originally bought this bank as a book-value bargain, and have been delighted to see than management has grown book value - and the book-value multiple has been increasing.
Earnings are up 45% this year, and have grown by more than 30% on average over the past five years. The return on assets is 1.23%, so they are performing much better than many of their small-bank competitors. In spite of the excellent performance, the shares trade with a P/E of just 11, and are at 1.3x tangible book value.
Allison is correct that you can pay a higher multiple of book value for banks that are top performers with strong earnings growth and high ROAs. While his bank didn't make the current list, a little digging showed that Home Bancshares was a growth bargain right before the shares took off on a strong run -- which has seen the share price almost quadruple.