- The chart below shows the total yield of the ARK Financials ETF (ARKF), the Financial SPDR ETF (XLF) and the top 10 ranked financial stocks in KCR’s model
- The ARKF ETF specializes in “Fintech” and suffers from 2% equity dilution – existing shareholders are paying -2% to subsidize the holdings of ARKF
- In contrast, the XLF ETF and our top 10 ranked financials offer investors high levels of income
- The stocks in ARKF’s portfolio are eroding their investors’ ownership percentage
- The owners of old-fashioned financials are getting paid to own them
We don’t think this is complicated. Do you want to pay to own expensive stocks or get paid to own cheap ones? In our just released White Paper we explained the case for old-fashioned financials.
In an income starved world we understand the appeal of XLF’s dividend yield. With that said we believe there may be better financial companies to invest in than just a value-weighted ETF. In the exhibit below we show some basic fundamentals of:
- KCR’s 10 top financial stocks from our S&P 500 rankings tool
- The XLF ETF’s holdings
- The ARKF holdings as of the most recent filing available to us
To repeat ourselves: we don’t think this is complicated. For investors looking for stocks to buy for the long-haul, we would suggest the best financial stocks are not to be found in the brave new world of expensive “FinTech.”
Are Bank Stocks Good Investments: A Brief Dive Deeper into Old-Fashioned Financials
- The chart below shows the growth in book value of the S&P 500 Financials over the last 30 years
- The sector has compounded book value at a steady 9.8% per annum
- That rate of growth includes the devastating losses in the Great Financial Crisis
- We believe novel financial ETFs like ARKF have sucked capital away from safe profit centers
- Durable financial stocks have compound returns almost perfectly in-line with book value
We believe the line below is a simple testament to their ability to compound wealth over the long-term.
In March we highlighted that stock prices of credit-card companies were trading at record discounts to the market. In April we highlighted the extraordinary spreads of legacy financial stocks to the broad market. As explained in last Wednesday’s White Paper, we believe Financials still represent some of the best opportunities in the market.
In the Federal Reserve’s recently released stability report they discussed the health of America’s banks and brokers. Bank of America, JPMorgan Chase and other large components of the financial select sector SPDR XLF lack excitement. But what they do offer is healthy dividend yields sourced from some of the strongest balance sheets seen in decades.
Investing in Financial Stocks: Two Very Different Options!
America’s old-fashioned financials offer products and services critical to the health of the US economy. They are not going away any time soon. And, according to the Fed, “Leverage at banks and broker-dealers remained low…[and]…Bank capital ratios are above pre-pandemic levels.” The report did note that life-insurers were vulnerable as they chase yield in response to low interest rates. Fortunately, they represent less than 4% of the weight in XLF.
In contrast, we believe the novelty and excitement around the “disruptors” in finance has gone too far. ARKF holds companies with enormous market capitalizations that sit atop negligible profits if not outright losses.
In recent Quick Takes we explained the disastrous track-record of investing in “innovation.” We advocated for safety when investing in today’s market. We also penned a brute-force rant leaning on the wisdom of Richard Sylla explaining how nonsense becomes dogma in manias like today.
Financials ARE Experiencing Elevated Earnings
The KCR research team gets things wrong, and we are not afraid to admit it. Any newsletter that talks constantly about their brilliant calls is, in our view, probably suffering from a common form of attribution bias.
Our brains are wired to forget or discount areas where we are wrong. We also take credit for good “calls” even when they might have occurred for reasons totally outside of our original thesis. We are not immune to such behavior.
What we try and do, however, is to always be transparent. In that spirit, here are some data points of concern over financials.
The chart below shows that the total earnings of the financial sector today are at never-before-seen records. One member of the KCR research team has been vigilant in pointing to elevated profits in the sector. Due in part to investment banking and trading, overall profitability may indeed fall. We would never want to mislead anyone.
The chart below shows the return on equity of financial firms. Financials’ ROEs are actually fairly muted despite soaring profits. This is simply a sign of how high book values are today.
So, the profits above are not pouring in due to outsized risk and leverage. Remember, as discussed earlier, banks and broker dealers have some of the lowest levels of leverage in over 40 years of history.
We believe it is important to recall that leverage at Broker-Dealers rose to nearly 50x in 2007. Currently the ratio is below 20x today. This fantastic article in the Atlantic from 2012 is well-worth your perusal in our opinion. It reminds us that leverage was not the only problem.
Credible methods of risk surveillance were eviscerated. The industry shifted from a culture of partnership to a bonus-culture driven by gambling with other peoples’ money. These factors helped blow the system up.
Re-reading the article made us laugh. In it the author worries that the onerous rules that financial firms now operate under might suppress financial innovation.
We believe the Fed report does a great job highlighting the shift in financial innovation. Effectively, risk has simply been moved to those supplying Private Equity with record leverage. Worse, that leverage is being used to buy firms with dubious adjustments to “EBITDA.”
We ask our readers to contemplate the following questions:
- Where has financial speculation shown up in the stock market?
- Where do you see the excesses in leverage and lending?
- Who are the borrowers and what are they doing with the money?
- What firms have recently shifted from private to public business models?
- Are old-fashioned financials behaving ANYTHING like they did in 2006-2008?
To us the answer is all-too obvious. As always, we encourage our readers to consult with a professional individual financial advisor for personalized advice and retirement planning. We cannot recall markets as precarious as those we see today.
KCR is acutely aware that our disciplined and historically informed approach to investing has been out of favor. We continue to believe that economic gravity is inevitable. For investors interested in Cheap Stocks with Dividends, Income Investing and other means of finding safety oriented income in equities, please know we have authored well over a dozen papers on the topic. We encourage research and prudence as not all dividends are created equal!