Yesterday's column sparked a lively discussion about value creation and destruction in the stock market. I talked with a few like-minded friends last night and the conversation turned toward financial companies that were not increasing the value of their business. I was of the opinion that underperforming financials that are not growing their book value and earnings are likely to become takeover targets as long as they are not financially impaired in some manner. A list of such companies would be more of a shopping list than a sell or avoid list.
I sat down and ran a screen to look for underperforming financials this morning, and I found some interesting stocks on the list. I noted that there were quite a few investment-related firms on the list. The investment landscape has been changing over the past five years with the explosion in ETFs and index investing, and that has taken a toll on some firms.
Och-Ziff Capital Management (OZM) has seen its stock price fall by about 45% this year as the firm has seen redemptions from its portfolio of hedge funds. In addition to trends toward passive investing, the asset management firm has had to pay fines and penalties of $400 million to settle a case involving bribery and corruption in Africa. Analysts believe the firm will see significant withdrawals at the end of the fourth quarter as a result of the scandal, and that has weighed heavily on the stock price. Still, the firm has more than $30 billion under management and many of its funds have been performing well in 2016. The company eliminated the dividend for the current quarter to preserve cash but could reinstate it in 2017 once the news flow surrounding the stock begins to settle down. If the firm comes anywhere close to the profit estimates for 2017, the stock could post significant gains over the next year.
Severn Bancorp (SVBI) in my hometown of Annapolis, Maryland, also makes the list of underperforming financials. It struggled with loan losses in the aftermath of the credit crisis, but in the past year it exited its consent agreements with regulators, paid off its TARP preferred and has been able to add back its deferred tax assets. The bank appears to have turned the quarter, and I am a big fan of management and the markets in which it operates. The stock is trading at about 96% of book value, and although I have a high degree of confidence that management can continue to improve the performance of the bank and get the stock price higher a takeover announcement would not shock me.
There is a similar situation at another favorite up in my old stamping grounds. Bay Bancorp (BYBK) was reorganized in 2011 after the bank failed in the credit crisis and had to take write-downs and charges over the ensuing years that caused a pretty significant drop in book value. The bank has turned the corner and is now growing by acquisition. I am also a big fan of management at this bank and think we will see solid asset and earnings growth in the years ahead. It serves an incredibly attractive market with operations in Baltimore, Anne Arundel, Howard and Harford as well as south along the Baltimore-Washington corridor, so I would not rule out a potential takeover of this bank, either. The shares are trading at 1.06x book value at the current price, so the stock is still cheap.
Hartford Financial Services Group (HIG) has recovered a bit since its disastrous second-quarter report sent the stock tumbling. Third-quarter results were much better and the personal lines of business were a little better. Commercial lines were strong and investment returns were much better in the quarter as returns from its hedge fund investments were much better year over year. Management is confident the situation will continue to improve and expressed that confidence by announcing a new, $1.3 billion equity repurchase plan as well as a 10% increase in the quarterly dividend. Loews (L) owns the majority of the company, so a sale is highly unlikely, but the company appears to be on the right track The stock is trading at book value right now, and I think that patient long-term investors will be well-rewarded for owning the stock.
Financial companies that are underperforming but still financially viable make a pretty good shopping list for aggressive yet patient investors.