Seeking Alpha: Finding the Bottom in Financials (13 July 2008)

Finding the Bottom in Financials

I've read and heard countless investors who have been thinking the banks were a "good deal" since the first big market sell off in January 2008. Since then many are down another 60% - some even more. Every month I see new investors looking to pick up a "bargain" in the financials without realizing the only bargains have been short positions. Most investors have been programmed by the financial media to always buy stocks when they go down because "in the long-term they are a great value." Well I don't know about you, but long-term to me means at least 20 years. And anyone who considers long-term any shorter than that needs to consider these sobering facts:


Since making its highs in March 2008, the Nasdaq is still down by over 55%; that's going on 8 years folks. In the 'best of scenarios' I cannot see those highs being tested for at least another 8 years.
Since making its highs in 1990, the Nikkei is still down more than 65%. Next year will mark 20 years since the Nikkei approached 40,000.

Finally, since making its highs in 1999, the Dow is now by about 3% after 9 years. Most likely the Dow will go considerably lower.

These are things to consider when buying stocks in general. But when we are talking about the biggest banking crisis ever, things look much worse. The financials continue to write down assets and take losses. And they still have no idea how large the total losses will be. Finally, they continue to sell off assets and raise capital using debt, and more so by issuing new equity.

Now, what do you think is going to happen to say, Citigroup (C) once it realizes all its losses. Next, consider how the future of its ability to deliver earnings after selling off assets. Finally, consider what the shareholder dilution will do to per share earnings. Yet, Citigroup is in much better shape than most of the other banks. Before it's all said and done you should expect to see most of the financials trading in the teens, some the single digits (as we already see). As for Goldman Sachs (GS), I'm betting it will break down well below $100 before it's all said and done.


When you take huge losses, you can recover as long as you have strong assets to deliver earnings. But when you are selling off a good portion of these assets your ability to deliver earnings will be diluted. These dilutions are even more severe after you have issued more shares.


"Bottom-fishing" as they call it isn't an activity amateur investors need to be involved with. Some bottom-fishers have already been fooled many times in the past 6 months and if they have any cash remaining, they are likely to be fooled again. But if you do plan to take a stab at catching a bottom, you need to stay away from distressed securities; in this case, distressed industries such as the financials, autos, airlines, and soon to be retailers.


But if you are determined to bottom-fish, you need to contend with the high possibility that things are going lower. And the trip back up is going to be slow and nerve-racking. Those of you who are looking for a bottom need to stick with stocks that are not distressed and have already declined due to other issues, such as the drug makers. Medicare Part D combined with the retirement of up to 80 million boomers will position these stocks for at least a decent recovery. And in the meantime you can collect the huge dividends. My top pick for this strategy is Pfizer (PFE). While a large market sell off could take it down another 2 points, the current dividend yield of over 7% is quite a deal. And note that in its 41-year history of being listed on public exchanges, it has always increased the dividend.


In conclusion, with rare exception, I do not envision any point in time when I will buy the financials hoping for a long-term recovery. In the best of scenarios, the only way they will be able to mount a reasonable earnings rebound will be through share buybacks or reverse splits. But that is unlikely to happen anytime soon if ever. Consider that Citigroup still has not realized the need to eliminate its dividend completely. It would rather sell off revenue-generating assets to raise cash like the one announced today in order to appease nervous shareholders.



But with 5.25 billion shares outstanding and an annual dividend of $1.28, this $7 billion ($4 billion post-tax) asset sale only allows them to continue dividend payments for one year. In contrast, they have lost a powerful retail presence in France, and all of the future earnings it would have brought. These banks need to wake up and start managing their business in crisis mode rather than the irresponsible mindset that got them where they are today. So if you think the banks will be a great buy when they do bottom, you should reconsider. You money can be invested elsewhere with much lower risk and higher returns. And while inflation is sure to eat away at any cash, at least you don't risk losing it all.



Disclosure: Long PFE