Whenever the conversation turns to stock sooner or later I am going to talk about community bank stocks. There are other small pockets of opportunity in the stock market like small REITs, some oil stocks and special situations but the most compelling opportunity in the market is the community bank stocks. The bigger ones need to buy to grow assets and earnings. The smaller ones cannot survive independently because of regulatory and technology costs. We all know it is going to happen over the next few years so now we are just haggling about price. In the meantime book values are growing by round 6-7% as credit conditions improve and banks can use excess capital to buyback stock at the current low levels. Deal multiples are creeping higher and are currently running right around 135% of tangible book value. Since we can buy a decent portfolio of small banks with sound loan portfolios, plenty of capital and at least one activist investor involved at 90% of book or less I question why more people aren’t doing this?

I am usually shouted down by the chart guys, the tech fans, the biotech buyers and the unknowing financial suicides known as retail options traders. The more I talk about the little banks the more I feel like John Adams in the musical 1776 with the crowd shouting for him to sit down as he argues the same point over and over. Of course John Adams was eventually proven right and so far so have I. I expect that to continue.

When not crusading for the small ban I spend a lot of time looking for bargain issues in the broader market. We are not finding many but I run a lot screens getting ready for the next inventory creation event. I try to channel my inner Munger by yelling at the neighborhood kids to get off my damn lawn and then looking for those industries and sectors where I can practice sitting on my ass investing for many years with large compounded returns. I keep lists of stocks in the cybersecurity and warfare, drone and robot technology infrastructure, alternative energy, pollution control, REIT, and agricultural sectors that will benefit from what I see as emerging social demographic and economic trends over the next ten and even twenty years. I also have on the list the price I would be willing to pay for them. I keep this updated every quarter or so and although the buy prices may look ridiculous now they won’t if we get a major market event. I had similar list pinned to the corkboard by my desk in 2008 and 2009 and it served me very well. The time to load your weapons is well before the battle starts.

I have no idea when we will see a market event but I can tell you that after reading the recent Saint Louis Fed banker survey the disconnect between Mian Street and Wall Street is getting worse not better. Just look at some of the state by state Town Hall Meeting comments:

While borrowers are still cautious and real estate lending has rebounded, the North Carolina market has not reached prerecession levels.

Community bankers in New Mexico are not optimistic about their ability to attract new business in the current economic and regulatory environment

In northern New Hampshire, the real estate market has a high inventory of available properties. Unemployment is relatively high, with hospitality personnel and the self-employed struggling the most to find work. Many have lost jobs. For those who do have jobs, hours have been cut and many are working part time. Bankers feel there is still considerable “slack” in the North’s labor market that remains unaccounted for.

Missouri. While growth remains relatively flat, opportunities for business expansion and formation do exist. For example, Missouri has a large number of empty buildings available for commercial, retail and warehouse purposes. However, bankers noted that there is minimal new commercial business formation which, of course, causes these buildings to go unused.

Overall, community bankers in Mississippi believe that the economy is improving, but they are not confident that positive growth will continue.

In Massachusetts economic decline in certain areas, as well as unemployment, is forcing many loan modifications. Most delinquencies are from owner occupied loans, making these types of loans risky for many banks.

Kansas is experiencing limited business development in major metropolitan areas. The population of areas like Topeka has grown slowly, resulting in similarly slow growth in business activity, capital expenditures and acquisitions.

Iowa is seeing slow-to-no growth throughout the state, with the rural areas having the most difficulty developing economically.

Business development in Indiana is not robust, but modest improvement is noted.

In general, bankers perceive that new business formation in Illinois is very limited.

It is not pretty once you get outside the beltways and bypasses of our nations major urban areas It certainly is not consistent with a booming stock market that is trading at 20 times trailing earnings with a forecast for a second quarter in a row of declining profits

Smarter people than I have noticed the growing disconnect. Sam Zell said Wednesday on CNBC that there was a disconnect between the reality and the stock market. He told the network that “"The best example I can give you was last Monday when the stock market was schmissed (great word) down 300 and everything was horrific. I looked at the screen and said I don't think there's anything that I want to buy. I didn't see anything that jumped up and said that’s value. We subsequently had a recovery that I don't think fits any economic judgment. There's a significant missing of demand, not only in the United States but worldwide.” He pointed out the difference between equity compensation and revenue employment and said that the pockets of strength in the economy are fueled by equity gains not revenue improvement.

Stanley Druckenmiller was a little emo repointed in his remarks recently. He said that “We’ve had a tremendous amount of debt growth, particularly in the corporate sector. There is good debt growth, and bad debt growth. Good debt growth is when you borrow money, and it goes into capital spending. But almost 98 percent of the current debt growth has gone into M&A, corporate buybacks, leverage buyouts, i.e., into financial engineering. One trillion of buybacks and 4 trillion of M&A is a job reducer. I don’t know exactly what the Fed thinks they are getting out of ZIRP. What you are getting is just a bunch of financial engineering, and you are setting up the possibility of another asset bubble bust.”

So what do we do in the meantime? We buy small banks, hold lots of cash and wait. It worked out pretty well for Charlie Munger, Mr. Womack, Andy Beal and Hetty Green so I am pretty confident it will work for us as well.

Tim