Monday, November 20, 2006

Long COF/ Short AXP

The premium price/book valuation AXP holds relative to COF still isn't justified, regardless of the markets love affair with another Buffett favorite. The time horizon for obtaining your low risk alpha is probably 18 to 24 months for those entering into a a pair trade. But you can expect 15% to 20% on this trade over two years. Remember KO, another Buffett long-term holding, now in the doghouse for ten years running, while underperforming PEP by an ungodly amount. This one is easier, since COF has an unusually robust track record, generating an ROE over 20% annually since it was spunoff in the early Nineties, with the recent decline in ROE due to less profitable acquired companies. Those extended the "longevity" of the cash flow, and were accomplished because the credit book was intentioanlly shrink (smart in my opinion; ask J Dimon). AXP's premium looks even richer since the spinoff of Ameriprise Financial. The disposal of that unit seem to have been a lose-lose proposition, with the AXP name evaporating after so many years of investing in the brand.
The long/short of it is that COF is trading at 1.3 book while earning a mid-teens ROE. AXP is reporting peak earnings and ROE inthe 30% range. It disposed of the high capital business Ameriprise (formerly AMEX advisors) to make numbers look even juicier. In reality, though it makes the valuation even dicier. It may be a 30% ROE business at the peak, but more likely will be a 20% ROE (or substantially lower) at the trough. My money is on Richard Fairbanks and COF to catch up.

No comments: