Tuesday, 5 June 2012

Grow or Die. Really?

Grow or die. Acquire or be acquired. Build it or kill it. And so go the banking platitudes. Now, perhaps those that invoke these phrases have strategies that compel them to grow. Shareholder value, so the logic goes, is created if I grow my balance sheet 10% per year and my earnings, because I'm realizing economies of scale, grow faster.

But what if you adopt the strategy of the tortoise? Go slow. Be methodical. Right size your cost structure as you go. Prune the tree frequently. Or what if the markets where you exist can't support 10%+ growth? You are pushing the proverbial rock up hill expecting your employees to beat a plodding market, year in, year out.

Calamity say the consultants, the investment bankers, the rock star banks. You must grow or die! In this environment, how could you possibly face the industry headwinds without doubling your size?

But wait a minute. If we are a public financial institution, what do our shareholders expect? Would a 10% total return be sufficient? It certainly is greater than our industry has been delivering, regardless of the size. In fact, as a disgruntled Citi shareholder, I put to you that their size worked against them. The risk on their balance sheet was (is) incomprehensible, even to them. I bought in at $50, which is now the equivalent of $500 due to a reverse stock split so they can increase their embarrassingly low share price. Today they trade at $25. Their clarion call should have been grow AND die.

What if, in the board room of a community financial institution, your strategy team decided to go slowly? What would your shareholders say to 5% earnings growth that translated to 5% stock price appreciation? Not too sexy. But what if your strong profitability allowed you to pay a 5% dividend yield. Now we have a 10% total return to shareholders delivered by a steady hand. Such was the strategy of City Holding Company, a $2.8 billion West Virginia bank. Its 10-year growth rates, represented in the accompanying table, doesn't exactly wow analysts.

But look at their 10-year total return to shareholders compared to the industry. Slow growth, combined with a 50%+ dividend payout ratio resulting in a 4.5% dividend yield delivered impressive returns. Compared to the rest of our industry, off the chart returns.

How do those that sound the growth siren square City Holding Company, and the many slow growth, highly profitable financial institutions like them?

I would like to hear from you.

~ Jeff

Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works out. You read that I invested in Citi, right?

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