Buy Financial Stocks vs. the Index?

  • FACT: Bank of America earns 30x the profits of ZM, but BAC is only ~3x bigger
  • Sometimes the greatest investment ideas can come from a simple chart
  • The dashed line below highlights periods when financials are in the 95th percentile of cheapness relative to the index like today

THESE PERIODS HAVE HISTORICALLY BEEN FANTASTIC ENTRY POINTS VS. THE INDEX OVER THE ENSUING YEARS.

Price to Sales Spread: S&P500 - Financials

As always, a rigorous fundamental review is a critical precursor to any investment. The chart below shows that, historically, if you just bought Financials when they were as cheap relative to the S&P500 as they are today your odds of outperforming were very high. Specifically:

  • 68% of the time you beat the market with average excess returns of 11% over the next 12 months
  • 60% of the time you beat the market with average excess returns of 14.9% over the next 24 months
  • While there are no guarantees it is worth remembering that “all of Las Vegas was built on a ~2% advantage”

KCR’s research team understands that “fintech stocks” are all the rage today. Wall Street has infused these companies with valuation multiples that imply huge profits ahead. Unfortunately, the long-term price targets that are being set on these firms often look to us like the work of investment banking teams rather than credible analytical models.

Financial services, wealth management, and the products and services provided by most financial institutions are, in many ways, commodities. We are not here to downplay the tremendous change companies like PayPal holdings, square and others have brought to the world of payments. But PayPal has a $300bn market cap and earns $4bn in profits. Compare that with a firm like Goldman Sachs, with annual earnings approaching $20bn and a market cap of only $135bn.

Our views are merely that capital has been inhaled into “new” financial services companies that provide very simple services at low margins that will be under pressure. Meanwhile, the most durable, proven, and profitable financial firms are priced like they are going out of business. This anomaly is all the more interesting given current interest rates.

Should interest rates lift off from the zero bound, the bank holding companies that have lending businesses could see their stock prices rise. Right now, many “old financials” are earning record profits on the back of euphoric markets which are causing explosive earnings per share increases on the back of an IPO and trading bonanza.

The market clearly isn’t giving these stocks credit for these supranormal levels of profitability. Even cutting the legacy financials’ profits in half, the stocks still look downright cheap to us. In the coming months, we will be writing a far more in-depth piece on financials. In that research, we hope to make the case that not only are “legacy” financials cheap today, but they are cheap while sitting on record amounts of capital.

KCR believes there are tremendous opportunities for investors who are willing to look at the facts today in the context of history rather than anchor their fears in the past and their hopes in the future.

Top Financial Stock to Buy Now in Our View:

If you would like to see the Financials favored by Kailash’s Investment Tools, click here. As a reminder to our readers, these lists are picks based on our proprietary ranking engines. Our work has been in circulation for well over a decade. Our research is based on best-of-breed behavioral finance and stems from what the history books teach. Very simply, human beings make the same mistakes again and again. Our goal is to help our readers avoid making those mistakes and encourage research efforts that are contrarian in nature.

We believe that where there is consensus, crowding, herding, high multiples, and other behaviors documented over centuries, the outcomes are almost universally unfortunate. Independent thought that focuses on a calm and rational examination of the facts on the ground has been and continues to be one of the most successful methods of compounding capital.

As our White Papers, Quick Takes and Charts for the Curious document in detail: seeking out firms of uncommon quality at reasonable to cheap multiples has been one of the most time-tested methods of compounding wealth over time. Our work takes a safety-first approach, and our goal is to help investors find the stocks that others are momentarily ignoring.

By focusing on anomalies like the one we have identified in financials here, we hope to help people stay grounded. We recognize that during a time when teenagers appear to be getting rich speculating in unproven stocks it can be difficult to stay disciplined. Our goal is to help you avoid chasing the crowd. Please reach out to info@nullkailashconcepts.com if you would like to learn more or fill out the “Contact Us” form on our website.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

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