Forget Apple and McDonald's; Look at Small Banks

 | Jul 26, 2016 | 11:00 AM EDT
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McDonald's (MCD) had a bad quarter, Caterpillar (CAT) had a blah one and General Electric (GE) had strong results but the bears quickly pointed out that orders were weak and GE's core industrial segment lagged. But it's a different story at the small publicly traded banks that I focus on, where solid earnings and a bullish new study show that the good times should roll on.

Second-quarter earnings are coming in strong in the segment, with solid year-over-year gains as loan growth continues to offset low net-interest margins. Consider what Provident Financial (PROV) reported this morning -- diluted earnings per share that grew 21% year over year to $0.34 per share. Or check out First Bank (FRBA) , which announced that net income soared 92.9% to $0.15 per diluted share vs. $0.08 a year earlier.

Meanwhile, Anchor Bancorp ANCB has hired an adviser to explore strategic alternatives, while EverBank Financial (EVER) is in takeover talks that shareholders should healthily profit from.

KPMG surveys small banks around the country each year and recently released a report showing that "a sizable portion of survey respondents remain cautiously optimistic about maintaining growth in the next few years. The banks we polled say they are upbeat about the headway they are making in transforming operations, making inroads with new customer segments, and developing new products and services."

However, many small banks continue to feel that $1 billion in assets are the key to survival. Just 8% of bankers that KPMG surveyed feel that banks below that asset level can remain independent.

In fact, 41% think banks need $5 billion in assets to succeed as independent institutions. After all, small banks face high regulatory costs and need to spend money on new technologies to capture and maintain customers and run at high efficiency levels. That's going to lead to more merger-and-acquisition activity in the segment.

In fact, KPMG's latest survey found a big sea change this year in small bankers' attitudes toward M&A. Some 23% of those polled last year reported no M&A plans as either buyers or sellers, but that fell to just 11% this year.

For example, 43% said they were "very likely" or "somewhat likely" to sell -- way up from just 21% who felt the same way in 2015. Many have apparently reached the conclusion that financial services isn't friendly to smaller banks any more, so it's time to sell. At the same time, 40% of bankers surveyed this year told KPMG that they're "somewhat likely" or "very likely" to buy another firm.

Bankers who achieve growth via M&A and taking market share away from big banks should see strong earnings growth as efficiency increases. That should drive their firms' stock prices higher over time.

The Bottom Line
Listening to the discussions about earnings season would drive me mad if I were trying to trade the same stocks that the rest of the world loves.

Many companies are reporting earnings that exceeded analyst estimates while trailing last year's results -- but that's still seen as "bullish." It's a maddening mix as the bulls look for ponies and bears look for clouds in the sunshine.

But I believe that this focus on quarterly earnings is no way to run a company or ascertain a stock's real value. By contrast, it's grow-or-sell time for many small banks, and that's as close to a win/win for investors as you'll ever see.

So, I'll let the rest of you worry about what Apple (AAPL) will report tonight. I'm going to read a book, watch a ballgame -- and rely on a win/win strategy of investing in this "trade of the decade" as banks continue deliver market-beating and wealth-building returns!

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