Back at the beginning of 2008, one segment of the market
was starting to look pretty darn appealing: small banks.
Indeed, more than 20 small banks were trading for less than
two times book value in April, while posting
trailing-12-month returns on equity north of 15%. That
notable list included
Preferred Bank (Nasdaq: PFBC),
First Midwest (Nasdaq: FMBI),
and Silver State Bancorp .
But I hope you didn't invest.
Why small and cheap is good
See, Preferred Bank and First Midwest are down
more than 60% since then, and Silver State is out of business
altogether. Sure, all investors should seek out
cheap small caps with good operating metrics; stocks like
these can provide outsized returns to long-term investors, to
the tune of
more than five percentage points
per year. But the recent experience of small-cap
banks imparts an important lesson about the difference
between
trailingmetrics and
futureoutlooks.
As you've probably heard on the news, the entire financial
sector has been sledgehammered by tightening liquidity,
thanks to a subprime mortgage writedown bonanza. Former
financial stalwarts like
Capital One (NYSE: COF) and
State Street (NYSE: STT) got crushed, as did
businesses such as
CarMax (NYSE: KMX) that made financial
products just a small part of their operations.
Excuse me while I ... state the obvious
That industry carnage is the reason why
small-cap banks looked cheap earlier this year, and why
they've gotten "cheaper" today. Still, I'm not buying. Here's
why:
Early is wrong
Now, if you also like cheap stocks (and
tally-ho if you do!), you're ready to tell me to stop looking
a gift horse in the mouth, to take cheap when I can get it,
and to
get ready to buymore if the banks
I should be buyingtoday fall further.
That's fine and dandy in theory, but as master money
manager Ron Muhlenkamp reminded me when I shared these same
thoughts with him last month, "If you're two years early,
you're one and a half years wrong."
There's good news, though: Recent market volatility means
that there
arecheap small caps with good operating metrics
outsidethe banking industry. Our
Motley Fool Hidden Gems
small-cap investing team has our eye on a good number of
them.
To see the stocks we're recommending today,
click hereto join
Hidden Gemsfree for 30 days. Continued... |