# A good time to buy bank shares?



## nukenelly (8 Oct 2008)

Given that prices are on the floor and at the liklihood of some of the main banks going under is still quite low, would this be a good time to take a punt on buying bank shares with a focus on medium-to-long-term gains?

I'm thinking alomg the lines of Michael O'Leary's decision to go out and order a fleet of planes after 9/11...


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## z103 (8 Oct 2008)

How lucky do you feel?

I wouldn't say the chances of at least one Irish bank being nationalised was too remote. Until people start getting mortgages, I can't see how banks' future business is going to look good. So we are going to have to wait for the end of the recession.


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## limerickboy1 (8 Oct 2008)

if u wait until the end of the recession to buy shares then you will have missed the major part of the move up


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## MichaelDes (8 Oct 2008)

limerickboy1 said:


> if u wait until the end of the recession to buy shares then you will have missed the major part of the move up


 
No one is tipping buying bank shares not even contrarians. Everyone is running for cover with cash, hence the dollar strengthening temporarily. 

_What in your view will be the future earning per share, based on banks profitability in 2009 etc?_

Don't judge looking at the past but only what's staring at you now and into the future. Most likely global recession, and probably protracted until 2010.



nukenelly said:


> I'm thinking alomg the lines of Michael O'Leary's decision to go out and order a fleet of planes after 9/11...


 
In the present climate he'd probably sell them if you want.


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## georgesoros (8 Oct 2008)

nukenelly said:


> Given that prices are on the floor and at the liklihood of some of the main banks going under is still quite low, would this be a good time to take a punt on buying bank shares with a focus on medium-to-long-term gains?
> 
> I'm thinking alomg the lines of Michael O'Leary's decision to go out and order a fleet of planes after 9/11...



How do you calculate this sentence ?  *'the liklihood of some of the main banks going under is still quite low' *?????


And of all the factors to consider when investing, even if a bank does not go over, that does not mean it wont be sold off for 1 euro for all share capital. The problem is we dont know whats inside the books of the banks.


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## MichaelDes (8 Oct 2008)

georgesoros said:


> that does not mean it wont be sold off for 1 euro for all share capital. The problem is we dont know whats inside the books of the banks.


 
At a quid, with decent debt to earning ratio - I'd be willing to punt.


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## charlie MacZ (8 Oct 2008)

Anyone tell me the quickest way to buy bank shares online without going to the individual banks?


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## Marc (11 Oct 2008)

Interesting question and like many questions I see on askaboutmoney it is essentially looking for a forecast.

Well, let me let you all into a big secret - its impossible to forecast the future. Nobody can do it. I met with an analyst a few months back who told me "Bank of Ireland are yielding 10% and are on a P/E of less than 10 and have never cut their dividend at these prices they are a bargin" 

If I had taken that "expert advice" when the shares were 6 Euro each, they are now 2.57 each!

Most people I meet seem to expect a financial adviser to somehow look into the future and make a forecast about which shares to buy or which fund manager or hot tip sheet is going to make them rich.

This is speculation not investment. Speculation is fine - as long as you understand that is what you are doing and don't confuse it with investment.

The problem with speculation is that you are just as likely to be wrong as you are to be right. For you to win, someone has to lose!

There is another way of looking at the world, based upon scientific empirical evidence.

The expected future return on any investment is a factor of its risk.
That is to say risk and return are related. Fact.

The single largest factor on the table is the cost of capital - that is why it is called capitalism.

Two factors have a proven scientific effect on the cost of capital for any company 

1) The size of the company - a small company has a higher cost of capital than a big company and therefore investors expect and require a higher investment return to compensate them for the higher risk
2) The value of a company as measured by book to market. Ie the value of the company as measured by the accountants divided by the market value. A company with a high book to market value has a higher expected return than a company with a low book to market value.

So, on this basis, banks generally are moving further and further into this area they are becoming smaller companies with higher book to market values. The expected future return is therefore increasing relative to the market as a whole.

But here is the catch - which banks are going to make it through this? How many more are going to fail? If a bank is nationalised and you are a shareholder - you can get nothing at all. That is a big risk.

Another secret: Again nobody knows the future. Really, I know its hard to accept sometimes (especially if you are a stockbroker reading this) but really, nobody knows for sure 100%. So trying to guess which banks to buy has to be a mugs game. The expected return from speculation is zero less the cost of doing it.

This is proven time and time again with studies into mutual funds which show that on average a fund manager underperforms the market by their annual management charge. In practice you would have been better off with a monkey, a dart and a copy of a stock sheet. In fact you would on average have outperformed by around 1.5% because the monkey would have worked for bananas!

So, would I put money into a single Irish Bank. No, of course not. Far too much risk. A UK bank? Nope! What about the US no. 

Would I buy the whole market across the world and  hold as many companies as I possible can and simply catch the expected market rate of return over the long term (10 to 20 years) you bet I would.

Incidentlly for those of you who currently have no  faith in capitalism  over the last  20 years  this  expected return from the market has  averaged  6% above a cash deposit.

Ah say the sceptics, the last 20 years are not representative. Good, I agree.

Over the last 100 and some years the worldwide equity risk premium is about 4% above cash. You take a risk, you expect to be rewarded. Your reward from buying (and holding) the market is, on average (with some big swings in there) about 4% above cash.

If you don't like the swings -take less risk. Put less into equities, or take risks you will be rewarded for.

Risks that I will be rewarded for would be if  I tilt my portfolio slightly towards smaller companies and high book to market companies because I know over the long term that I will be systmatically rewarded for this specific form of risk. This is not a forecast it is an empirically proven scientific fact.

So would I exclude banks from my portfolio - no of course not. Would I speculate on bank stocks - no it's a mugs game.

Risk and return are related - equity investments are risky. Do we all see that clearly now?

Therefore I expect to be rewarded at the rate of the capital markets over the long term (at least 10 years+)  but this requires me to capture the market return efficiently (ie the whole market, not an active investment fund, not market timing which can't be done, not stockpicking which can't be done, not putting 50% 75% or 100% of your portfolio into the ISEQ when it makes up only 1% of the entire planet)

To be a sucessful investor all you need is access to a low cost form of passive investment which captures the whole market return globally and allows you to tilt your portfolio into those areas where there is a proven reward for the risks taken.

There are some companies out there who seem to offer something approaching this - but there are lots of limitations which an investor needs to understand. ETFs have their shortcomings, Tracker funds have their shortcomings.

For example:  small companies are typically illiquid with huge spreads - ie it can sometimes cost you 6% to get in. The premium from buying smaller companies is on average about 4% above large companies. So trading costs are critical here or you will wipe out the higher expected return that is on the table.

Recent events have shown the markets to be a risky place for the unaware. There is no such thing as a free lunch. Risk and return go hand in hand. If you are making 20%pa on the way up - you have to expect a 40% or 50% fall. Why would it be any other way?

“The idea that any single individual without extra
information or extra market power can beat the
market is extraordinarily unlikely. Yet the market
is full of people who think they can do it and full of
other people who believe them….Why do people
believe they can do the impossible? And why do
other people believe them?

Daniel H Kahnemann, 2002 Nobel Laureate in
Economics.


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## Dogsbody (11 Oct 2008)

Well said Marc.


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## micktpg (11 Oct 2008)

Hello Marc, I'm new to the stock world and I'm having trouble understanding some of the terms you used. 
1) First of all i have looked up several definitions of Capitalism and still can fully clench the  definition ! Could you give me a simple description ?

2) Also could you explain the following:
"a small company has a higher cost of capital than a big company".

3) And how can people find out the "value of a company " in relation to Book to market value ?
4) And last but not least equity investments : 
"generally refers to the buying and holding of shares of stock on a stock market by individuals and funds in anticipation of income from dividends and capital gain as the value of the stock rises." would the above be a good description ?


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## Marc (11 Oct 2008)

Let me spare you the pain of having to take a 4 year economics degree.

Now, this is a really brief summary and is intended to be simplistic.

Firstly you need to know that markets are generally accepted to be an efficient means of matching buyers and sellers through the mechanism of prices.

Supply and demand for any good or service should always tend to be in equilibrium so that those who wish to buy pay a price which matches those who wish to sell. This is true of markets in general and not just the stockmarket.

If you just accept that this works you can save yourself a lot of pain and suffering. If you don't believe me, the stockmarket will educate you but it has a habit of handing out large tuition bills.

(For those of you who want to argue that markets are not fully efficient, I agree that there are some inefficiencies and that other steps (eg regulation, laws etc) are required to ensure an orderly market. However, there is no evidence that a fund manager can identify these inefficiencies in advance and with sufficient regularity to pay for the additional costs of active fund mangement and consequently it is virtually impossible to profit from the inefficiencies)

So, in a nutshell  capitalism is the means by which those with capital, lets call them capitalists, allocate their capital to achieve an expected return.

This expected return is a function of the risks being taken.

If I deposit my capital with the post office I have a lot of security - but my expected return is low. Capitalism assumes that I will not be satisifed with this safe return, mainly because over time, my capital will not maintain its real value allowing for inflation. I will see everyone else doing better than me (call it growth or progress) and so I will want to join the party.

A bank is less safe than the post office, as we are seeing in spades right now. So, I expect a higher return. I expect to be rewarded for taking the additional risk.

Government bonds are typically safer than corporate bonds (ie loans to governments are more likely to be paid back than loans to companies) 
The interest rate reflects the underlying risks of repayment. So, loans to Argentina or Iceland should pay a higher interest rate than loans to Switzerland.

Finally, taking a share in a business offers a higher expected return than anything else (including property*)

So, the logic of the efficient market is that capital will tend to gravitate into investments in companies as over time this offers the highest expected return.

As I said capitalism is called capitalism because everything is based on the return on capital employed.


"a small company has a higher cost of capital than a big company".

This just means that a small company is more risky than a big company. Would you rather invest in IBM or Greggs the Baker (a real company listed in the UK)

Think like a bank - I'd rather lend my money to IBM anyday. So the cost of capital for the baker is higher. They have to pay more for capital. So, the expected return on my investment is higher. Ie as an investor, I require a higher return on my investment to compensate me for the higher risk.

Watch Dragons Den on the BBC! These people are there mainly because the Banks have already decided that most of the ideas are as mad as a box of hot frogs. If you want me to invest in your company, I want half of it!

Risk and return living together in perfect harmony.

3) And how can people find out the "value of a company " in relation to Book to market value ?

This is a more tricky subject. I'll come back to this one.

4) And last but not least equity investments : 
"generally refers to the buying and holding of shares of stock on a stock market by individuals and funds in anticipation of income from dividends and capital gain as the value of the stock rises." would the above be a good description?

Yep that is the bulk of it. There are other issues to consider like where you stand in line  in the event of a company going bankrupt - which is again really relevant right now. 

First in line are the banks then senior debt bond holders, then subordinate bondholders then preference shareholders then common stock holders.

Equity investment almost always means common stock holders. Again last in line, greatest risk, highest expected return.

Hope that helps.

*Property has a lower expected return than equity. Why?
Because if I am in business I can rent a property to conduct my business - whatever it might be. I expect to make a profit after costs (including the rent).
So, it is logical that if the expected return on property was higher than on equity, all companies with a property would simply shut down and rent out their buildings. This simply does not happen. Why? Because the process of added value from being in business creates wealth.


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## webtax (12 Oct 2008)

It looks like there will be more turmoil in the market tomorrow, with the UK government launching its rescue package for the banks...

http://business.timesonline.co.uk/t...ectors/banking_and_finance/article4926316.ece

In the event of a part nationalisation or forced merger of Irish banks the share prices here would have further to fall, so don't invest anything you cannot afford to lose (completely).


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## beekeeper (12 Oct 2008)

nukenelly said:


> Given that prices are on the floor and at the liklihood of some of the main banks going under is still quite low, would this be a good time to take a punt on buying bank shares with a focus on medium-to-long-term gains?
> 
> I'm thinking alomg the lines of Michael O'Leary's decision to go out and order a fleet of planes after 9/11...


 
 Hi Nukenelly,

I have been a professional trader for 15 years and there are 2 key sayings that you should bear in mind in markets such as these:

1) The trend is your friend - the trend is down at the moment and because the market has fallen so dramatically when it does turn back up there will be plent of oportunities to get on board .. 

2) Dont try to catch a falling boulder ..  

In my opinion, there is a very good chance of a complete change in the Irish banking landscape in the next 6 to 12 months. The govt didnt bail out the banks without somekind of strategy to tighten up the ship. The only way to tighten up the ship is to have less banks, whether this is through failures, mergers or acquisitions.

If you have a few quid to spare look for oportunities outside of the banking world, as i feel one or 2 banks will be "worthless". There are and will be plenty of companies/sectors that will prosper from all this carnage. Therein lies your oportunity !! 

Good luck


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## Morgan 2.0 (13 Oct 2008)

That was a bloody good post marc.

In fact, I've put your posts into a notepad file so I can read them again later!

Keep up the good work!


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## Bronte (13 Oct 2008)

Yes I liked Marc's post too. Don't understand what a senior bond holder is though in a bank, is that an individual who has purchased bonds or what is it?


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## faolteam (13 Oct 2008)

can i ask marc or anyone what does it mean by a bank been nationalised mean ?


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## cole (13 Oct 2008)

Good post Marc, I see a lot of Benjamin Graham there, a must read for anyone who is thinking about investing. Excellent point re the difference between speculation and investing.


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## Bronte (14 Oct 2008)

faolteam said:


> can i ask marc or anyone what does it mean by a bank been nationalised mean ?


 It means it's taken over by the goverment and becomes a state bank rather than a private enterprise.


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## lemur (14 Oct 2008)

cole said:


> Good post Marc, I see a lot of Benjamin Graham there, a must read for anyone who is thinking about investing. Excellent point re the difference between speculation and investing.



Guys, ALL investing is speculation. 

Re: buying banks, There is a saying in the market. 'Don't try to catch a falling knife'. 

Would want to see a double bottom on the charts with MACD, RSI divergence before buying banking stocks if I was going to buy them at all.


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## lemur (14 Oct 2008)

beekeeper said:


> Hi Nukenelly,
> 
> I have been a professional trader for 15 years and there are 2 key sayings that you should bear in mind in markets such as these:



what do you trade beekeeper?


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## Josey (14 Oct 2008)

From someone is is hundereds of miles from a degree in economics and  likes to gamble & dabble a bit in the market.
I was thinking about throwing a few euros in AIB.
Can anyone explain to me what AIB on NYSE is $9.63 (>7eu) which i can buy via my US ameritrade a/c and on ISEQ (eu3.20)...obviously looks like 3:1 or is there another explaination ( i preume they track eachother).
Cheaper fees with the US, thats what made me look it up there.


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## beekeeper (14 Oct 2008)

lemur said:


> what do you trade beekeeper?


 

Hi Lemur

I am a FX trader but dabble a bit in FX options, a few equities, oil, gold and silver.


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## lemur (15 Oct 2008)

beekeeper said:


> Hi Lemur
> 
> I am a FX trader but dabble a bit in FX options, a few equities, oil, gold and silver.



Are you based in Dublin Beekeeper? Send me an email if you want. 

peterbr@yahoo.com


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## Investmind (24 Oct 2008)

Indeed excellent post by Marc

Probably one of the most educational posts ive ever seen
Keep it up!


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## DerKaiser (24 Oct 2008)

beekeeper said:


> Hi Nukenelly,
> 
> I have been a professional trader for 15 years and there are 2 key sayings that you should bear in mind in markets such as these:
> 
> ...


 
Go for McDonalds & Ryanair! Cheap and cheerful, their profits will rise and the price/earnings ratio merchants will see to it that they get overvalued throughout the recession.

Bank shares are very low because of the high chance of them being nationalised or, more likely, having to make a rights issue.

To throw in another cliche,

When the shoe shine boy is quoting Warren Buffet, then Warren Buffet if f***ed!


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## zephyro (24 Oct 2008)

Marc said:


> Two factors have a proven scientific effect on the cost of capital for any company
> 
> 1) The size of the company - a small company has a higher cost of capital than a big company and therefore investors expect and require a higher investment return to compensate them for the higher risk
> 2) The value of a company as measured by book to market. Ie the value of the company as measured by the accountants divided by the market value. A company with a high book to market value has a higher expected return than a company with a low book to market value.


 
3) PEAD http://en.wikipedia.org/wiki/Post_earnings_announcement_drift

4) Momentum http://en.wikipedia.org/wiki/Momentum_(finance))


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## limerickboy1 (25 Oct 2008)

bank shares will underperform for the forseeable future. they are reducing risk and will have govt people on the boards. this will ensure that risky lending wont go on. as much as we hate the way the markets have crashed due to the bad practises by the banks, its these lending practises that also leads to booms. this wont be allowed for a long time again so the banks profits will be reduced for a long time


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## hatfield (25 Oct 2008)

I dont understand when people speak of investing in banks why they are so narrow minded that they only consider Irish banks. If you cant come up with a reason why investing in Irish banks is better than investing in banks with a more global business e.g  Citibank etc then shouldnt you go do some homework first ?


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## FlyFishing (25 Oct 2008)

I dont want to speculate on the Irish Property market but many people believe that property market has crashed , when it in fact has not.

The real crash is yet to come ( dont forget the prices rose 360% in 10 years so 30-40 falls is only the beginning ).

So for that reason and that reason alone, i would not advise anyone to buy into Irish Banking stocks.


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