Monthly Archives: March 2015

Some links

Barry Ritholtz interviews Cliff Asness (AQR) (audio only)

A good post on success factors for spin-offs

How to make 68,6% p.a. with a French Life Insurance contract

Damodaran with everything you need to know about the “New Tech bubble”

If you are interested in off-shore oil drilling, check out the official report on the Macondo desaster.

Why Ikea from Sweden is so sucessful selling the same furniture all around the world.

John Hempton from Bronte on why he likes Rolls Royce (the engine maker)

Sitting on cash as a market timer can lead to “cash addiction”

A deeper look into Svenska Handelsbanken (With a little help from Warren Buffett)

This is the follow up post on my first post where I compared Handelsbanken to Deutsche Bank.

Whenever I start to look at a company more seriously, I do a quick Pro/con list, starting with the Cons first in order to cool down my desire to quickly buy a stock:


1. It’s a bank
2. Avg P/E over the last 15 years has been ~11 compared to 17 now (so historically expensive)
3. current P/B at 2,0 is higher than 15 Year average (1,7)
4. current price/tangible book at 2,2 vs. 15 year average at 1,95
5. Almost 100% more expensive (P/B) than most European banks
6. high exposure to potentially “frothy” Nordic real estate markets
7. significant amount of capital market funding (deposit to loan ratio clearly below 0)
8. past performance also due to "Luck" of not being active in Southern Europe, many Nordic banks look good, especially Swedish banks
9. threat of continued technological change (online banking, peer-to-peer lending, etc.)
10. analysts are extremely negative, significantly below all peers (on Bloomberg, from 33 analysts, only 1 has a buy, 16 holds, 16 sells). Handelsbanken is Number 600 of analyst consensus in the Stoxx 600.
11. we are current in a frothy stock market environment and the stock chart looks aggressive

Let’s look into more detail into these issues.

Re 1: It’s a bank

Many value investors stay away from banks, mostly due to the 2008/2009 crisis where former highly regarded banks (Lehman, Bear Stearns;WaMu, Countrywide) basically disappeared over night. On the other hand, Warren Buffett’s single biggest stock investment is a bank, Wells Fargo at around 27 bn USD for their ~10% plus stake.

One of the great things about Buffett is that he usually explains what he does. Wells Fargo is not different. He actually explains it in his 1990 annual report.

He starts explaining why they don’t like banks in general:

The banking business is no favorite of ours. When assets are twenty times equity – a common ratio in this industry – mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the “institutional imperative:” the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.

Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly managed bank at a “cheap” price. Instead, our only interest is in buying into well-managed banks at fair prices.

So this is pretty clear statement from Buffett: If you buy a bank, buy a good one.

Let’s look at the next paragraph:

With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen. In many ways the combination of Carl and Paul reminds me of another – Tom Murphy and Dan Burke at Capital Cities/ABC. First, each pair is stronger than the sum of its parts because each partner understands, trusts and admires the other. Second, both managerial teams pay able people well, but abhor having a bigger head count than is needed. Third, both attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, both stick with what they understand and let their abilities, not their egos, determine what they attempt. (Thomas J. Watson Sr. of IBM followed the same rule: “I’m no genius,” he said. “I’m smart in spots – but I stay around those spots.”)

He clearly invested in the people running the bank. That somehow contradicts other statements from him where he claims only to invest in businesses which could be run by idiots. Anyway, the second learning is: Buy good banks with good management..

Let’s look next, why and when he bought:

Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled – often on the heels of managerial assurances that all was well – investors understandably concluded that no bank’s numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.

As we have seen the 2008/2009 financial crisis, Buffett seems to like buying banks especially in crisis situations where they sell really really cheap. This somehow also contradicts the first paragraph. Clearly Buffett prefers to buy cheap if he has the chance.

In the following part, we can clearly see how far Buffett’s thinking went those days:

Of course, ownership of a bank – or about any other business – is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic – the possibility of a business contraction or financial panic so severe that it would endanger almost every highly leveraged institution, no matter how intelligently run. Finally, the market’s major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

Interestingly, real estate prices look expensive in 1990, even before the big 20 year boom. He then gives us a hint how he actually puts numbers on risk:

Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank’s loans – not just its real estate loans – were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

In any case this did not deter him from buying Wells Fargo and they have been a great investment for him. Just for fun, I checked out the performance of Wells Fargo since 01.01.1990. Including dividends, Wells fargo made 15,6% p.a. since then, that is even 2% p.a. better than Berkshire returned for its shareholders in the same time period !!!!

Re 2: Avg P/E over the last 15 years has been ~11 compared to 17 now (so historically expensive)

This is clearly an issue. As we have seen above, buying banks at distressed prices is much more fun. One counter argument is that current margins at Handelsbanken are also below their historical means. If you assume mean reversion for instance to the 10 year average net income margin, than this would lead to an overall average valuation level. So no reason to worry here but it is clearly not a bargain either. On the other hand, Wells fargo for instance would have been a great investment for Buffett in any case as long-term for such a great company the entrance point has less relevance.

Re 3. current P/B at 2,0 is higher than 15 Year average (1,7)
Re 4. current price/tangible book at 2,2 vs. 15 year average at 1,95

Similar to 2, both measures look expensive compared to the past. “Normalized” the look better but clearly not a bargain.

Re 5. Almost 100% more expensive (P/B) than most European banks

This doesn’t worry me much. As Buffett mentioned, you should buy “good banks” not weak banks below book value.

Re 6. high exposure to potentially “frothy” Nordic real estate markets

Here we can use Buffett’s sample calculation:

At the end of 2014, Svenska had around 1.114.000 mn SEK property loans. If we assume 10% of them defaulting with a loss of 30%, we would end up with an expected loss of ~ 33.000 mn SEK. Compared to the net income of 15.000 SEK for Handelsbanken in 2014, this would mean a loss 2 times their annual profit. Not as comfortable as Wells Fargo back then, but US Banks in general have higher margins. On the other hand, there are no “no recourse” loans in Scandinavia, so one could assume that the stress scenario might be lower.

Re 7. significant amount of capital market funding (deposit to loan ratio clearly below 0)

The dependence on capital market funding was the major problem for banks in the 2007/2008 crisis. Now however, the situation has turned. With negative rates, many deposit rich banks have huge problems because you can’t really charge your retail customers for deposits (yet) but you “earn” negative rates on excess deposits. For Handelsbanken, this is much easier because they don’t have a lot of excess cash on the balance sheet. So in the current environment, this is actually an advantage.

Ee 8. past performance also due to "Luck" of not being active in Southern Europe, many Nordic banks look good, especially Swedish banks

That is absolutely true, however Handelsbanken long-term ROEs etc. are the best even within this Group.

Re 9. threat of continued technological change (online banking, peer-to-peer lending, etc.)

This is a very interesting aspect. Many banks here in Germany are closing branch after branch, whereas Handelsbanken aggressively expands by opening new branches. Their focus on branch banking is clearly counter cyclical and I am not sure how this will work out long-term. I do think that there will be continued demand for “In person” bank services but I have no idea to what extend.

Re 10. analysts are extremely negative, significantly below all peers (on Bloomberg, from 33 analysts, only 1 has a buy, 16 holds, 16 sells). Handelsbanken is Number 600 of analyst consensus in the Stoxx 600.

This is actually a big plus from my side. I own other stocks (Admiral, TGS) which score equally poorly in analyst’s ratings. In my personal opinion, analysts mostly run their ratings on a top down approach. They start with the sector and if they don’t like the sector, most companies within that sector will get bad ratings. Very often in a next step they then rank companies badly which look “expensive” compared to similar companies. They almost never look a more specific aspects. A relatively expensive company like Admiral in a tough sector will get a bad rating, non withstanding any long-term significant competitive advantages etc.

For me, badly rated companies in tough industries but with long-term competitive advantages are one of the few corners of the markets where I can find value. So this would be a clear plus for Handelsbanken as a potential investment.

Re 11. we are current in a frothy stock market environment and the stock chart looks aggressive

Looking at the chart, it is quite interesting how the stock price accelerated despite the bad analyst ratings:

looking at the shareholders list one can see that US funds seem to like the stock and buy into it, especially Capital Group, T. Rowe Price and others. Skandinavian funds rather seem to be more cautious. Personally, I am also hesitant buying into such a chart, but int theory one should better ignore it as this could be very similar to “Anchoring” a very common behavioural bias.


Looking at the “Cons” which I have identified int he first step, I don’t see a deal breaker against investing. However, the current price level is rather “fair” than cheap. This could be justified if there would be a clear upside with regard to growth and/or growing profitability.

As the post got quite long already, I will look into the upside potential in a separate post which should hopefully follow soon.

Short cuts: Admiral, KAS Bank, NN Group

Some quick updates on preliminary numbers form 3 of my financial stocks:


Admiral released “preliminary annual” numbers yesterday. EPS declined slightly which was not a big surprise. My take aways at a first glance:

– UK car still tough, UK comparison some issues due to competition, however cycle might turn in 2015
– slowing growth in Italy

+ Italy at break even, break even in Spain expected for 2015
+ US growing strongly
+ Intenational comparison sites profitable

The CEO letter is again a must-read for anyone who is interested in Admiral and/or insurance. These guys are really different.

KAS Bank

Kas Bank came out already a few days ago with a press release on preliminary 2014 numbers. EPS almost doubled to 1,65 EUR due to the already mentioned one time effect. “Normal” earnings would have been around 0,74 EUR per share.

On the negative side, KAS Bank’s equity has been siginficantly reduced by an increase in the pension liability due to lower discount rates. Additionally they announced that they will expense 5 mn or so p.a. of the one-time gain as “investments”. Top line income acually fell but they were able to cut costs quicker. Overall, if low or negative rates will remain for a lnger time, the upside potential of KAS Bank now seems to be limited.

NN Group

Finally, NN Group came out with their 2014 results already 4 weeks ago. As with any life insurance company, they are quite difficult to interpret. What I found quite intereting is the fact that they said that their Solvency II ratio under the Standard model is 200%. Normally, most internal models show much higher solvency ratios than the standard model. In my opinion. NN Group remains the best (and only !!!) European Life insurance company to invest in despite the overall extremely difficult environment.

In any case, I will need to analyse all cases in more detail once the annual reports come out, especially with regard to KAS Bank and the pension issue.

Performance review February 2015 – Comment “Interest rate surrender”

Performance February

In February, the portfolio gained +5,7% against +7,2% for the Benchmark (Eurostoxx50 (25%), Eurostoxx small 200 (25%), DAX (30%),MDAX (20%)). Still worse than the benchmark but closer than in February. Year to date, the score is +9,2% against +16,1% for the benchmark.

For the first time since its inception (1.1.2011), the portfolio has now doubled in value with an overall gain of +100,6% against +67,3% for the benchmark.

Outperformers in Fabruary were Miko (+16,5%), Draeger (+14,7%), KAS Bank (+12,6%) and TFF (+12,4%). Losers were Koc (-10,2%), Installux (-5,2%) and the TRY Depfa Zero (-3,2%).

February showed the typical “catch up” of small caps which often outperform with a certain time lag to the liquid markets. Overall with around like 20-30% of cash & cash equivalents, I can clearly not expect to match the benchmark in such a phase. This is the strongest start into a calendar year for the stock market since I run the portfolio and my low beta approach then doesn’t work so well.

Portfolio transactions

February was a slow month. The two exceptions were that I sold out the remaining part of Cranswick and increased my Electrica position by 1%. Direct cash ist now at 12,8% plus a further 11% in cash like positions (HT1, Depfa LT2, MAN). I clearly see the problem of some shares reaching fair value and not generating a lot of great new investment ideas.

The number of holdings is now at a reasonable 25. Above 25 I don’t feel too comfortable, so if I would add a new position, I will most likely “kill” an old one. Most obvious candidates would be my smallest holdings, Koc and Trilogiq. The month end portfolio as alaways can be accessed via the “Current portfolio” page.

One remark here on my portfolio holdings: Currently, a lot of companies issue “preliminary annuals”. I always hesitate to fully read them because often they lack important information which is only disclosed in the annual report. I find it much more time effective to wait for that annual report and then decide what to do, unless something really dramatic happened.

Comment: “Changing interest”

Normally I tend to stay away from most macro related issues because it makes my head spin. This comment will be a small exception. First an interesting datapoint: What do you think was the best asset class in 2014 at least in “developed” markets ? Well, US stocks with 15,3% look strong but the German 30 year bund made around +34% in 2014. For many people this is surprising as how you can make +34% in a year with an instrument which had a yield of 2,8% at the end of 2013 but this is the “power” of duration and convexity.

But the even more interesting thing (at least for me) is that for the first time in my 20 year professional career in finance, most of the people I talk to have changed their expectations with regard to interest rates. Even back in the 90ties, everyone was convinced that interest rates could only go higher. The lower rates went, the louder the voices grew. Bond bubble, hyper inflation etc. etc. were the buzzwords and shorting the bund was the absolute “No brainer” trade.

Looking at the historical yield of the bund future (the proxy for 10 year Bund yield), we can clearly see that this “interest rates can only go up” attitude was to a large extent a combination of “Recency bias” and “Anchoring”:


It clearly shows that at least for the last 25 years there was no mean-reversion in interest rates.

I guess the events early this year, mainly the Swiss Franc de-pegging plus the Draghi announcement to buy 60 bn EUR monthly for the foreseeable future combined with negative yields all around have somehow silenced many of the pundits. With negative rates, being short duration now suddenly really starts to hurt. Keeping cash in a long tem pension portfolio until now did not really hurt, but now, if you really have to pay money for deposits, people do anything to get yield. It almost looks like that negative yields force many institution to “surrender” and go long duration, no matter how low yields are. It will be interesting to see for instance what “my friends” at FBD are doing after betting on rising interest rates for the last few years.

Historically, such large scale surrender situations have often marked a mid-term turning points. I would not bet on this nor am I sure that this observation is relevant. However it is definitely a change in expectations compared to the last 25 years. Which I find interesting.

18 observations from Berkshire’s 2014 annual report

Just an upfront note: I have written down those items while reading the 2014 annual report for the first time. Usually I read them at least twice. This year’s report contains a 4 page letter from Charlie Munger (page 39), nicely summarizing the “Berkshire system”. Overall, Buffett and Munger seem to emphasize in this year’s report that they see a great future ahead for Berkshire, even without them on board.

I would recommend anyone to read the annual report first before reading any comments from secondary sources. It is a lot to read but it is definitely worth your time.

My personal take is that it will be extremely hard for any succesor to fit into Buffett’s (and Munger’s) shoes. This company was built by and around two geniuses. Yes, the “Berkshire system” does have some enduring qualities but combined with the size of the company, it will be extremely hard to deliver outstanding performance ging forward.

Call for comments: Comments from my readers about what items you did find especially noteworthy would be highly appreciated !!!!

1. 50 year history

Read more

Recent Entries »