Monday, November 20, 2006
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.
The sub-sector with the greatest downside among the financial institutions (FIG) is the property/casualty (p/c) group. But, the best strategy for playing the FIG group is a long/short strategy, since the insatiable demand for stocks in this area seems unlikely to dissipate with all the liquidity sloshing around. Worldwide liquidity levele suggest a low rate environment is here to stay. In particular, the mid and small capitalization p/c stocks offer the most downside over the next few years (BER, PHLY), while select mortgage players such as CFC, FRE (yes mortgage stocks, though not credit oriented) still offer much more stable and predictable (on a relative basis) long-term earnings streams. These should be a hedge on the long side, for those unconvinced of the naked short case for property/casualty insurance. These two p/c insurance stocks are up five fold in the last five years in what everyone concedes is a commodity business. What gives? The ROE's (currently in the low twenties) are unsustainable and the decline (in ROE) could start to accelerate over the course of 2007 and through 2008; perhaps reaching breakeven levels by 2009/2010. Seems like a long time; But what is to be gained by owning them today? Those with short memories need to be reminded of Frontier Insurance, Gainsco, Fremont General, and Reliance, all of which liquidated in the late Nineties.