Going Up, Going Down
We’ve all heard the expression that a rising tide lifts all ships, but the reverse can be said of an ebbing tide. Sometimes investors panic when a particular industry, sector, asset class, or market falls out of favor. They throw the proverbial baby out with the bathwater.
We saw it during the financial crisis in 2008. Pretty much the entire U.S. market (heck, the global market) sank at a drastic rate. But smart investors knew that not every stock that was hitting rock-bottom levels was trash. And those who did their homework and invested in valuable companies during the drought made triple-digit returns over the course of the next few years.
We saw it even more recently as oil prices plunged in 2014 (and remained extremely low compared to the $100+ per barrel prices of years past). Investors panicked, and the stock of every company involved, from junior E&P companies to super-majors like ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX), plummeted along with crude prices.
Very few thought to look at the balance sheets and SEC filings of these companies. As a result, many investors lost their shirts. But there were some amazing deals to be had if you just did a little research.
I pocketed a handy 30%+ by investing in Valero (NYSE: VLO) when the industry tanked.
You see, VLO had a super-strong balance sheet and incredibly efficient operational margins. It had tons of cash on hand to help weather the storm. It also had operations that allowed it to sell its oil at a profit (albeit small) even at those low levels.
I’ll be honest, I could have made more, but I had set trailing stops on my shares at around 20%. So once the prices dropped 20% from the highest levels they’d reached since I bought, my shares were automatically sold. Technically, I could have been sitting on 50%+ gains if I’d had better timing. But I digress…
Asymmetric Trades = Astonishing Potential
Hopefully those examples get my point across. When good companies are priced the same as bad companies, smart investors can make BIG profits.
Well, we’re seeing another case of a low tide bringing all the ships to rest on the sand right now. “Where?” you ask. In a place many investors are afraid to look: the European financial system.
You see, professional traders and retail investors alike are terrified that there’s an impending collapse coming for the banking stocks across the EU. I don’t blame them. Easy monetary policy has been running rampant across the globe. The Fed wasn’t the only central bank pumping party drugs into the markets.
In fact, the ECB kept the juices flowing even longer than our own central bank. Now the markets are suffering from the old proverbial hangover. They drank too much jungle juice, and now they’re reeling, worshipping the porcelain altar, swearing they’ll never drink again. You get the picture — shoot, we’ve pretty much all been there at one point or another.
And European banking stocks are feeling the after-effects even worse than most. Market makers are scared that the entire system is about to collapse around them and they’ve already priced the crash into the banking stock prices. This is where our opportunity, as smart investors, lies.
If we can find just one or two banks that have solid fundamentals and a management team that’s not been partying like a bunch of frat boys, we stand to make some serious profits. And we don’t really even need the financial system in the EU to rally to win here. All we really need is for this collapse to not happen. Literally, if nothing happens, we win big. And if the EU’s financial system rallies, well, we win really big. Like a walk-off home run in the final game of the World Series big.
Finding Treasure in the Trash Can
Before you go buying every European banking stock you can get your hands on, let’s talk about what kind of banks we really want to get involved with…
Some of these stocks are in the gutter for a very good reason and are likely to get washed right down the sewer no matter what happens in the EU’s financial sector. We’ve got to look for the gems that are hidden in the rubbish.
I’m talking about banks with extremely low current valuations — P/E ratios well below the industry average and low P/B ratios are a good place to start. I’m also talking about banks that haven’t gotten sucked into risky loans — like ones to countries such as Russia and the Ukraine. Most of all, though, I’m talking about banks that are run not by the “smartest people in the room” but by the wisest.
After doing some serious digging, I’ve found just such a bank.
Go Dutch and Go Long
I’m talking about ING (NYSE: ING). Big Orange. One of the best-run banking operations in the world. I mean, these guys are really good. The stock sports a P/E of around 8 in a world where most banks trade in the 12+ range. The stock trades at about two-thirds its book value. And the management team just hiked the dividend to 7%.
For comparison’s sake, close peers Commerzbank (OTC: CRZBY) and Deutsche Bank (NYSE: DB) pay 2.6% and 4.6%, respectively.
What’s better is that much of the fear around banking stocks in the EU is based on loan books that are chock-full of risky ventures in Russia and the Ukraine. ING’s book, however, is relatively clear of these. It’s got about 1% of its loans exposed to Russian investment and even less (0.2%) exposure to the Ukraine.
Wise management kept the bank out of the rush to exploit unsure economies. That’s going to pay off ten-fold in the long run.
Another boon to investors (and to ING’s balance sheet) is the fact that management made the wise decision to get away from physical branches. ING is an entirely electronic bank (not counting its fascinatingly designed corporate headquarters, of course).
This saves the bank mucho dinero on a daily basis. It doesn’t have to rent any land or buildings. It didn’t buy properties at sky-high prices. It doesn’t even have to spend any cash to maintain structures. Again, a decision that’ll pay off big in the long run.
Best thing for U.S. investors, though, is that we can buy its ADRs on our markets without converting any dollars to euros. No heartburn tracking currency swings. No need to work out any complicated triangular arbitrage to enter and exit trades. Just simple buy and sell orders in a standard trading account.
You might get a little bit more bang for your buck by investing on ING’s home turf in Amsterdam. You’ll definitely get more liquidity. But the ADRs that I mentioned above will see the same type of positive momentum once the rest of the market catches on.
Remember, we’re not betting on a financial recovery or some huge banking rally here. We’re just betting that a complete collapse won’t happen. We’re betting against the analysts being right. And when was the last time you remember those guys hitting the mark?
So be smart, be patient, do your research, and chances are you’ll be a happy (and much richer) investor in the long run.
To your wealth and success,
Jason Williams
Follow me on Twitter @AllBeingsEqual
