Wednesday, August 20, 2008

Value Stimulus - PFBC:

Value Stimulus – PFBC:
In my posts labelled Value Insight I enjoy giving readers a perspective of my investing habits and what stocks or themes I might be currently researching, investigating or investing in that I perceive to hold value.

I focus a great deal on management in my stock analysis because through experience I've found that the habits, actions and personal interests of those in a decision making role can indicate what goes on behind the scenes of a company with certain accuracy and confidence. While this may or may not always lead me to invest in a company; it often helps to provide a balanced perspective of other factors I'm analyzing that influence my investing decisions.

I'm a firm believer that actions speak louder than words based on my personal and professional experiences. Investors over history have been badly led astray by CEO's and corporate officers who promise one thing and then do the opposite. Investors' base their decisions at times on these statements by management and often vent their frustrations with not knowing how to differentiate between the good & bad or when to steer clear of obvious trouble.

My 5% Rule and previous post on the Importance of Management might still leave some investors with their eyebrows raised, so I thought that I'd use a recent example as a better description of how I put the concepts of management to successful use when investing. In the wake of the subprime mortgage crisis and subsequent collapse of financial stock valuations I made a few key observations that went against the trend of the past few years. It's not uncommon for financial officers of large or small corporations to own a significant number of shares in their company through stock option plans or direct share purchases. Over the past twelve months I made the observation that CEO's, Board of Directors and other corporate officers weren't buying shares in any significant amount throughout this credit crisis.

The conclusions I came to were:

  • The current share prices, although having dropped 20-50%, didn't appear to offer management tangible value
  • Sale of shares was indicating that management had a lack of faith in the ability of the companies to curb losses.
  • Management anticipated the share price to continue dropping by not buying or stopping share purchases altogether on previously regular schedules
  • Share dilution via issuance of common & preferred shares to raise capital has yet to cease
  • Losses & write downs were still imminent and expected
  • Finding any bank stock where management was aggressively buying shares might indicate stronger fundamentals and a miss pricing by the market.

Of course the last conclusion, finding a bank whose management was buying shares aggressively, turned out to be similar to finding a needle in a haystack. To further frustrate my initial research I continuously found that the management of many of the large-cap stocks I was investigating were continuously making adamant statements that their dividends were safe, but weren't buying shares at these historically high yields. I soon found out why when those CEO's subsequently slashed the dividends weeks later and were given their walking papers shortly after.


Even though the US financial industry is highly fragmented, I decided to give up on my research of the large capitalized banks and instead focus on many of the smaller regional banks.


The criterion for further investigation was fairly simple:


  • Firms whose management and/or Board of Directors were buying shares in the company more aggressively than the previous schedule
  • Firms with higher loan quality and diversified business operations
  • Firms with a Value Stimulus of one or more of my Value Rules

After weeding initially through 30-40 names I came across two promising prospects for further research: Preferred Bank of Los Angeles (PFBC) & Associated Banc-Corp (ASBC).

In my previous posts on management I've brought up a few key items that I concentrate on to evaluate management. One of the most important is weighing what a CEO or corporate officer is saying and evaluating their actions. I listen to what management has to say and then I scrutinize what those individuals are doing behind the scenes to see if they're backing up their statements where it counts the most. One of the most important factors for giving management a "pass" in my analysis is ensuring that their interests are aligned with those of me and shareholders. A CEO can "state" publically that the company's' dividend is safe, but what is he/she doing with their own shares of the company?


CEO's and other stakeholders are just like you and me when it comes to their money. They might make more than you or I, but money is just as important to them to fund their lifestyles, needs and wants. A manager who has a significant vested financial interest in the company is likely to have the same interests as me as a shareholder and when they buy shares at depressed prices are likely doing so because they know they're getting a deal.


Why would a CEO buy 80% of his/her annual share purchases at a 52-week high when they can buy that same allotment of shares at a 52-week low?


One of the first surprising developments that I noticed about PFBC was in their Insider Ownership Filings which are required to be made public and filed with the SEC. PFBC started 2008 with 8% of their total shares outstanding (TSO) held by members of the Board of Directors and upper management. From January 1st to June 18th of this year that number swelled to just under 20%.


To put this into perspective, although PFBC is a much smaller bank, this would be similar to watching Warren Buffett & Berkshire Hathaway (BRK.A) purchasing over $9B worth of Wells Fargo (WFC) during the same time period. Add in that bank employees already owned 10% of the TSO and PFBC had 30% of the company's shares held by direct stakeholders involved in the day-to-day activities of the business.


Through my subsequent research I was impressed with the following information:


  • PFBC had continued to pay a dividend in difficult market conditions in line with their previously targeted payout
  • Total assets vs. loans remained conservative
  • Capital ratios of the bank remained intact without raising additional equity
  • 41% of California's Chinese population (a key target market) live within the operating geography of the banks' branches
  • Loan portfolio was dominated by commercial loans
  • High focus on wealth management which diversified into other revenue sources unaffected by the housing market
  • Geographic penetration of the bank was spread conservatively between residential and commercial areas of LA County.

After running more numbers I felt confident in the actions of management and the BoD's and began to track the bank closely on my watchlist. I felt the risk/reward was balanced in my favour since the fundamentals of the business remained sound and as the market continued to heavily discount the stock in sympathy to other regional bank failures I made a purchase of PFBC on July 15th.

I came to the basic conclusion that either management & the BoD's had more money than brains OR they knew the shares were dramatically under-valued.


I certainly don't advocate that an investor simply use this as an example for an investing thesis and put their capital at risk blindly. My initial research amounted to nearly 15 hours of investigation before I had a reasonable comfort level with determining what price I was willing to pay and evaluating the risk/reward of this investment.


This simply serves as an insight into how I conduct some of my research in value stocks and how I use management at times to evaluate an investment.


Disclosure: I hold positions in PFBC, ASBC, & WFC

This article was written by Triaging My Way To Financial Success. You may email questions or comments to me at nurseb911[AT]gmail.com.

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