Not too long ago, all the private equity leaders from around the world descended upon Berlin, Germany for the SuperReturn International conference to network, share ideas and get to know each other better.
One of the interesting things that happened right off the bat was that Apollo Global Management, Inc. (APO) Co-President Scott Kleinman said that we are all currently living in a state of “collective delusion.”
He noted that we are going to look back on this 10 years from now and wonder how it was ever okay to pay 25 times earnings before interest, taxes, depreciation and amortization for a business and expect to be able to make money running that business and selling it for a larger gain.
I tend to agree with that statement, as valuations for both private and public markets are absurd right now. Meb Faber recently pointed out that the cyclically adjusted price earnings (CAPE) ratio hit a very high reading of 40.
Now, a question for the audience… How many times in the last 200 years has the CAPE ratio hit 40 in a securities market anywhere in the world and then deliver positive returns over the next five to 10 years?
The answer is absolutely none. It doesn’t happen. This is a level that indicates excessive optimism and enthusiasm for stocks. I’m not saying it has to end right now or short the market, but looking out five or 10 years, we are living in a state of delusion if we think we are going to earn double-digit compound annual returns from this level. It’s almost impossible with a CAPE level of 40.
When you look at the market cap to gross domestic product (GDP) ratio, which Warren Buffett said was a pretty good indicator of the overall value of a market, it’s as high as it was or maybe even higher than it was in 1999, right before the internet bubble burst.
Stock prices in the large stocks that make up the index are priced at excessive, ridiculous, unjustifiable valuations. Of course, the justification that everyone uses for this are interest rates, which are so low that it “justifies” these valuations.
Well, I don’t know when, but at some point interest rates are going to go higher, and this whole theory is going to collapse. You’ll also see a collapse if bond yields continue to drift lower because a lot of what’s going on is a carry trade.
Stocks have been yielding more than the 10-year Treasury, which allows you to finance your stock portfolio with a low-interest margin loan, and the dividend covers the interest on the margin loan. So, you’ve got a great carry trade that’s been in place, and many institutions have been doing that for the better part of a decade ever since the yield relationship was distorted back in 2008-2009.
So, there’s a lot of factors in play and a lot of things that can go wrong for stocks. Second quarter earnings were as good as we’re ever going to see in terms of year-over-year growth rates, so they’re only going to slow down from here. A lot of the arguments for owning the big-name stocks are going to get more difficult to justify.
When we look at the S&P 500, for example, Apple Inc. (AAPL) makes up 6% of the index, Microsoft Corporation (MSFT) makes up about 5%, Amazon.com, Inc. (AMZN) makes up 3.7% and Tesla, Inc. (TSLA) is 2% of the index. The S&P is basically a giant technology fund, with about 25% of the index in tech and tech-related companies.
So, buying an index fund is not that nice, low-risk trade that you think it is. You’re actually buying quite a basket of high multiple tech stocks that trade at absurd valuations. If you want to make money over the next five to 10 years, doing it in the mainstream is going to be very difficult.
Yes, there could be some gains to be had for very good traders, but long-term passive ownership of the big, better-known stocks is probably going to have a negative impact on your net worth. So, what’s the solution?
Well, we need to look for special situations that the big institutions don’t own, which aren’t in the indexes and which will be spared from the selling pressure when institutions eventually decide to get out or you get half of the planet unwinding the giant carry trade as bond yields tick up above the yield of the S&P 500.
That means we need to look where nobody else is looking, and that’s in the thrift conversion market where there are some fantastic opportunities.
Blue Foundry Bancorp
Blue Foundry Bancorp (BLFY) recently did a thrift conversion, added a bunch of cash to the bank’s balance sheet and increased the book value to way over $15 on a $10 offering. The company has 18 branches with about $2 billion in assets, and when the takeover restrictions come off in three years, there will be immediate offers for this bank. It’s that attractive.
The company is primarily in single- and multi-family lending, with a great track record and non-performing assets right around 1%, which is well below what most banks are dealing with right now. They’ve got some commercial real estate assets, but not a lot.
And one of the reasons for doing the offering and getting away from being just a traditional thrift is that they wanted to be in a position to grow commercial relationships. They’re in one of the best banking markets in the world there in northern New Jersey, and several of the counties in their service area actually have average annual incomes of over $100,000.
It’s a very diverse business environment, and there are a lot of potential opportunities to do business with credit-worthy commercial customers in that region, which is a much more profitable business than just single-family lending. So, they’re hoping to be able to expand the commercial side of the business and open branches carefully in selected areas, using the offering proceeds to expand the bank’s presence in that very lucrative market.
Now, insiders were loading up on this stock in the initial public offering (IPO) and bought as much as they possibly could. Since the IPO closed and the stock has been publicly traded, they’ve continued to make open market purchases, including recently right around the current stock price. They have a lot of faith that this bank is going to go a lot higher, and I tend to agree.
Three to five years down the road, you’re not going to care what the stock indexes are doing because this stock is going to make you a lot of money. It’s ridiculously undervalued at just 90% of book value, and at some in the future they’re going to grow that book value between 5%-10% a year or perhaps more as the commercial business comes online.
And they’ll eventually sell this bank at 1.4 or 1.5 times book value or higher. So, there’s an enormous amount of money to be made in Blue Foundry Bancorp. This is a sleepy little bank in a great market that’s expanding into the commercial side of the business.
They’ve also got a new CEO who is young, aggressive, smart and talented with a great track record of growing banks and financial institutions. I’m super excited about this one, and at 90% of book it’s almost a can’t-miss proposition. It’s going to be really tough not to make fantastic returns with shares of Blue Foundry Bancorp.
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