Value Investing: Tools and Techniques for Intelligent Investment

Chapter 28. Financials: Opportunity or Value Trap?^[28]

Value investors are often a relatively homogeneous group. While each does its own research, they often tend to end up looking in the same places. This is a by-product of the tools and techniques they deploy in their quest for bargains. However, views on financials have created a schism in value land. One group thinks that financials are a clear opportunity. The other says that valuing financials in the wake of a bursting credit bubble is foolhardy. To us the margin of safety on the financials simply doesn't look big enough given the risks of a prolonged downturn.

• I have long argued that the long commodities/EM, short financials trade is the most overcrowded position in the market. I have no problem taking the opposite side of the popular long, and shorting the commodity and EM-related plays. However, the going long financials cause me more problems.

• One group of value investors, typified by Richard Pzena, argues that financials are exceptionally cheap. He argues that the current situation will not materially impair the future earnings power of the financials. As such the current situation is 'A typical credit cycle that will work its way out as other post-excess crises have, and without impairing the long-term ROEs of the survivors.' This appeals to the contrarian within me.

• However, on the other side, value investors like Steven Romick of FPA argue that 'Margins and returns on capital generated by financial institutions in the ...