VALUE: After Hours (S08 E08): A Deep Value Strategy in Financial Stocks

During their recent episode, Taylor, Carlisle, and Derek Pilecki discussed his Deep Value Strategy in Financial Stocks. Here’s an excerpt from the episode:

[Derek] Yeah, I think it’s a deep value strategy. I only focus on the financial services sector. So it’s non-bank financials, like brokers, insurance, non-bank lenders.

And, you know, I’m looking for names that have cheap valuation and for some reason why the valuation I think is going to change. And so I have a little rule of thumb. If I, if I can come up with a, an investment case, the stock will double in three years, I’ll probably own it.

So, you know, that could be something that’s trading six times earnings, they’re going to grow earnings 12% for three years, and the multiple is going to re-rate the 10 times and that gets me a double. And so just do that over and over. I think, you know, I think there’s particular businesses in financials that are, are attractive, that are either balance sheet light or grow attractively.

There’s some good growth banks. I think one very interesting thing in financials right now is there’s a lot of franchises that have good organic growth that you don’t have to pay a premium for that growth. And I think, you know, there’s some reasons for that.

I think people aren’t normally thinking about financials and growth. I think some of the banks that used to have growth multiples, those growth multiples went away after first Republican Silicon Valley failed. So, you know, I think you can find some interesting businesses right now and not that are growing, you know, low double digits that you don’t have to pay up for that growth multiple.

And but I think of it as a deep value strategy.

[Jake] How do you think about the potential left tail of, you know, I mean, it’s GFC obviously was sort of brought a lot of things to bear, but, you know, when there’s so much that you’re depending upon, how good is the asset side? And there’s that joke that, you know, there, there are less bankers than there are banks. How do you, how do you assess that?

And then try to chop off that left tail, I would imagine.

[Derek] Well, I mean, I think I’m pretty positive about the environment as far as, you know, where we are in the economy. I mean, I think after the GFC and then especially Dodd-Frank, the banks have a lot more capital and a lot more liquidity than they did 2006. And so I think we’re, you know, we’re not going to, we’re 18 years away since the great financial crisis.

If you think we have a financial crisis every 20 years, it should be happening, right? And, and I think that’s what makes private, the private credit talk right now scary because it’s, you know, about the right timing. I don’t think we’re going to have a systemic problem with private credit.

They run with a lot less leverage. And, you know, they’re, they don’t have to fire sale assets when they go bad. Like, you know, banks, as soon as they have a bad loan, the regulators are on top of them of like sell the note, foreclose the property and liquidate.

And so that kind of drives prices down and it’s not the best outcome where private credit can manage to the best economic outcome and manage through that. There’s not the same deposit funding that they, that forces them to be sellers. But, you know, so I generally think the banks, the banks are in pretty good shape.

And, you know, I think about recessions, the deep recessions we’ve had recently have been the savings loan crisis and the great financial crisis. And they’ve been because the banks stopped lending the main street in 0-1-0-2 in 2020. We had recessions that were pretty mild.

The banks continue to lend, you know, credit was available to main street. So I think, you know, if we have a pullback or a slowdown in the economy, the banks are pretty far away from turning off the spigot to main street. So I think we, we kind of would kind of muddle through any slowdown.

So I feel, I feel good. I think the, you know, the obvious fallacy in my positive outlook for banks is, you know, Silicon Valley and First Republic’s failures. I mean, I, but I think that was just interest rate mismanagement 101.

Like we learned during the 80s, you can’t lend long and fund short. And that’s exactly what they did. And so I think, you know, of course you can have individual institutions fail.

I think, you know, systemically, I don’t, I think we’re pretty far away from this, the system failing. But, you know, I’m, I try to be open minded about that positive view, but I think that that keeps me positive generally.

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VALUE: After Hours (S08 E08): A Deep Value Strategy in Financial Stocks

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