In running all my screen and back tests this week, I found one simple screen that outperforms all the others by a decent margin. It has beaten the S&P 500 by more than 50% over the past year and tops the rest of the value screens I tested for one-year performance. It is a simple three-factor model that shows one-year returns of 24.35% handily outperforming the 16.95% of the S&P 500. Best of all, the stocks were all part of my favorite sector: the small region and community banks. The trade of the decade has performed very well in the past year, and I expect this to continue for some time.
Two factors were a price-to-book ratio of less than 0.9 and equity-to-assets ratio greater than 10. The third factor was simply that the company had to be a bank. I didn't check for non-performing assets, Texas ratios or return on equity as I might with other bank screens. It was just a list of cheap banks with lots of capital. The resulting list was almost entirely small banks that saw their stock prices driven higher by continuing credit improvements and rising takeover premiums. Of course there were several banks on my list that received takeover offers during the year. The trade of the decade banks have done very well for the past several years, and 2014 has again been a great year.
I have been investing in bank stocks for decades now; those cheap banks with lots of capital have consistently provided solid returns, and I think they will actually improve going forward. The economic and regulatory headwinds faced by the smaller banks are going to force many of them to seek out merger partners to spread the coasts across a larger asset base. The larger regionals need to look for growth in a no-growth world and they will be seeking to buy it. We are seeing a perfect storm forming with one group of banks that needs to sell and another group that needs to buy. The resulting M&A activity is going to push valuation higher across the sector. The Darwinian small banks that survive will be those with superior financials; they will benefit from better credit conditions and increasing loan demand that will drive earnings and stock prices much higher over the next decade.
This year's list contains some familiar names. HomeTrust Bancshares (HTBI) has been one of my favorite stock picks in 2014. The bank has made some smart acquisitions to expand into Virginia and Tennessee and is positioned to make the leap form a community bank to a regional in the next few years. The stock is trading at just 80% of book value right now and the equity-to-assets ratio is over 14.
Louisville, Kentucky-based Republic Bancshares (RBCAA) is also looking to grow by acquisition. In the most recent earnings release, CEO Steve Trager told shareholders: "On a regular basis we are asked about our long-term acquisition plans and deployment of our excess capital. Although we have experienced a great deal of success growing our balance sheet during the first nine months of 2014 through internal products and business lines, growing through acquisition remains a key growth initiative in our long-term plans. We have deployed, and will continue to deploy, a large amount of resources to finding the right bank with which to partner." The stock is cheap at 86% of book value and it has an equity-to-assets ratio of 12.75.
Northeast Community Bancorp (NECB) has four offices in New York and four in Boston, so it's probably a bad idea to have a combined employees meeting during a Yankees-Red Sox series. The stock is cheap, trading at just 81% of book value and the bank has plenty of capital, with an equity-to-assets ratio of more than 17. The bank just announced a new buyback program for 5% of the outstanding shares, so that could provide some support for the stock price as we approach the end of the year.
There are 64 banks on the list; less than half o them are over $50 million of total market capitalization. Once again, I suspect investors will earn big by going small with the trade of the decade in community bank stocks over the next 12 months.