Fool's Eye View

[ July 4, 2000 ]

Help For Tardy Carpetbaggers

By Maynard Paton (TMFMayn)

Carburton Street, London -- As co-manager of the Qualiport, I've recently touched upon one of the holdings we hold, Lloyds TSB (LSE: LLOY). Now, anybody who owns a slice of Lloyds TSB, or indeed any other bank, will know that the recent share price performances within the sector has been pretty disappointing. The Qualiport bought Lloyds TSB at 755p last September. Back then, at that price, we thought it was in an "attractive zone". Yet, true to Qualiport form, the share price has continued its decline.

Now, I know that the Qualiport aren't the only ones to have an underperforming bank languishing towards the bottom of their performance chart. There are plenty of Fools who have banks in their portfolios, a fair proportion of whom were lucky enough to receive "windfall shares" when a flurry of building societies demutualised a few years ago.

Back then, banks were a stock market fashion, with institutional investors scrambling for the newly floated businesses. As the Wise bought at any price to fulfill their sector weighting obligations, so many a smart building society carpetbagger waved goodbye to their freebie shares.

Now that the demutualisation hullabaloo is but a faded memory, I'm sure that many investors who have held on to their windfall shares must look back with a tinge of regret. Looking at the share price performances over the past year or two, the rewards from the former carpetbagging opportunities now appear a little threadbare.

Tardy Carpetbaggers

Shares in Halifax (LSE: HFX) peaked at 944p in February 1998, and have since slumped to 595p. Alliance & Leicester (LSE: AL.) peaked at 964p in the same month and have since plunged to 581p. And Northern Rock (LSE: NRK) peaked in February 1998 too, at 660p, but the shares have since dived to 329p. Those holding shares of Woolwich (LSE: WWH) were fortunate to see their shares peak at 429p in June 1999, but today they rest at 269p.

It must be remembered that, at just about any price, those receiving windfall shares would have been handed "free money". But, with those seemingly ever-declining share prices, there must still be a fair amount of disappointment to bear for any tardy carpetbagger.

So, what should those hanging on to the former building societies do? I'm sure that hackneyed phrase "run your winners and cut your losers" comes to mind. You may think that banks, operating in a rather mature and competitive industry, have seen their best days. A switch to a company that is involved in something more growth-orientated, like mobile phones, microchips or flat loudspeakers, may be the answer. Having said that, I think the highly rated tech stock party will continue to endure its large hangover for a while yet.

A far better course of action would be to judge the banks' merits, and any investment alternative, not by the recent share price action but on valuation grounds. Banking valuations have slumped on fears of further interest hikes, fears of a slowdown in the mortgage and property market, and fears of a general increase in price-based competitiveness within the industry.

Warren Buffett comments on the subject of "fear" thus: "The most common cause of low [share] prices is pessimism -- sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer."

As nicos1 soundly remarks in this message, it's all about weighing up the gloom with the valuation: "Fear is generated from uncertainty, and it is exactly these two factors which create value in a share. Therein lies the punt. Very often, one has to face the fear element, which is holding back demand from a share, and take the plunge in the hope that these fears are unfounded or overdone. You are not going to have value delivered to you on a plate."

Having Faith in Dividends

Here are the valuations of the aforementioned banks, using the simple dividend yield based on forecasts for this current year.

Company              Recent      Prospective
                   Share Price      Yield


Halifax               595p           4.5%
Woolwich              269p           4.9%
Alliance & Leicester  581p           5.7%
Northern Rock         329p           4.7%

They are hardly overvalued, considering long-term government bonds (gilts) currently yield 5.2%. Taking the not-too-unreasonable assumption that each of these large banks will continue their "progressive" dividend policies over the next few years, increasing the yield at perhaps 0.4% a year, then a stark undervaluation can be clearly seen. Do the risks within the banking sector justify the mean ratings? Will the future danger all mean medium-term dividend cuts are on the horizon? I, for one, suspect this gloom-laden scenario is highly unlikely.

So, having had a quick peek at the valuations of the four former building societies, my feeling is that investors shouldn't be overly distraught by the ever-downward share prices. If anything, assuming you expect to be an ongoing long-term buyer of investments, then you should welcome the banking sector share price declines. Certainly, at the moment, those still with the windfall shares should cast aside thoughts of "cutting the losers" and instead seriously contemplate a top-up.

What Now?

• So, what is the Qualiport?
• Banking sector discussion board

Read these recent Qualiport articles on Lloyds TSB:
• Winning Banks
• Yielding To Lloyds
• Looking at Lloyds

Or read this Sector Dissector feature covering the Banking industry
Get to grips with different company valuation techniques